Payday loans may be coming to a bank near you.
They're marketed under a different name, but a handful of major banks already let customers borrow against their paychecks for a fee. And there are signs the option may soon become more widely available.
Banks say their loans are intended for emergencies and they are quick to distance themselves from the payday lending industry. But consumer advocates say these direct deposit loans -- as banks prefer to call them -- bear the same predatory trademarks as the payday loans commonly found in low-income neighborhoods.
Specifically: Fees that amount to triple-digit interest rates, short repayment periods and the potential to ensnare customers in a cycle of debt.
With a traditional payday loan, for example, a customer might pay $16 to borrow $100. If the loan is due in two weeks, that translates into an annual interest rate of 417 percent.
Since the borrowers who use payday loans are often struggling to get by, it's common for them to seek another loan by the time of their next paycheck. Critics say this creates a cycle where borrowers continually fork over fees to stay afloat.
Banks say their direct deposit loans are different because they come with safeguards to prevent such overreliance.
Wells Fargo, for example, notes customers can only borrow up to half their direct deposit amount or $500, whichever is less.
Its fees are cheaper too, at $7.50 for every $100 borrowed -- although that still amounts to a 261 percent annualized interest rate over the typical pay cycle. The amount of the advance and the fee are automatically deducted from the next direct deposit.
Wells Fargo admits that it's an expensive form of credit intended only for short term use. But customers can max out their loans continually for up to six months before they're cut off. Then after a one-month "cooling off" period, they can resume taking advances.
U.S. Bank, which has more than 3,000 branches mostly in the Midwest and West, and Fifth Third Bank, which operates 1,300 branches in the Midwest and South, offer loans with similar terms and restrictions.
"When you're allowed to be indebted for six billing cycles in a row, that's not a short-term loan," says Uriah King, vice president for state policy at the Center for Responsible Lending, an advocacy group based in North Carolina. "They call them short-term loans, but that's just not how they're used. And banks know that."
Even if customers can only borrow half the amount of their next direct deposit, that can be a significant setback if they're living paycheck to paycheck, King says. They'll likely need to take another loan to continue covering living expenses.
That idea is supported by a study by the Center for Responsible Lending that found direct deposit loan users relied on them for almost six months of the year. About one out of every four borrowers was a Social Security recipient.
It's not clear whether the weak economy has increased the use of payday loans. But a group that represents alternative financial services such as payday loans and check cashing, the Community Financial Services Association of America, says that demand for short-term credit has been rising at a steady clip in recent years.
This spring, Regions Financial became the latest major bank to offer the direct deposit loans. The bank, which operates about 1,800 branches in the South and Midwest and Texas, also announced that it would begin offering check cashing and prepaid debit cards in the near future.
The rollout of the products comes at a key juncture for the industry. Banks are under intense pressure to find new ways to squeeze profits from checking accounts in the face of new regulations.
One particularly lucrative revenue source -- overdraft fees -- was tightened about a year ago under a rule intended to protect consumers. The rule prohibits banks from charging overdraft fees without first obtaining a customer's active consent for such coverage.
The fees, which are disproportionately incurred by low-income customers, generated an estimated $37 billion in 2009, according to Moebs Services Inc.
Now consumer advocates fear banks will start nudging these same customers toward direct deposit loans.
Another concern is that direct deposit loans are tantalizingly easy to access for customers who need cash in a hurry. Because potential borrowers must already have an account with the bank, there's no application process and cash can be immediately deposited into checking accounts.
The banks' main regulator, the Office of the Comptroller of the Currency, says it has received requests for guidance on direct deposit loans and overdraft programs. In June, the agency issued proposed guidelines saying that banks should observe "prudent limitations" and that action should be taken when banks detect "excessive usage" by customers.
The agency does not spell out what constitutes prudent or excessive. But it noted that certain practices have raised supervisory concerns. Among them: the steering of customers who rely on Social Security and other federal benefits toward the loans and a failure to monitor accounts for excessive use.
Representatives for each of the four banks declined to disclose what percentage of its direct deposit loan customers are repeat users. They also declined to disclose how widely the loans are used.
The banks stress that they reach out to customers who show signs of becoming overly dependent by speaking with them about whether another form of credit might be more appropriate.
Wells Fargo also notes that it made changes this year to make the loans more consumer friendly. A spokeswoman for the bank, Richele Messick, said that fees were previously higher at $10 for every $100. Customers could also max out advances continually for a year before the bank cut them off.
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