Wells Fargo launched a widely available small-dollar loan Nov. 16, making it the fourth major bank to offer an affordable alternative to expensive payday loans. With the move, financial institutions that operate nearly 13,000 branches, or about 18% of all bank branches in the United States, now offer automated, near-instant small dollar loans to their customers.
This change unlocks access to borrowing for many checking account customers with low credit scores who might not otherwise qualify for bank credit. Banks have found that these customers are likely to repay the loans because of their previous relationship with the bank and because the loans are repaid in affordable installments over several months.
The maximum amount for these loans is set at $500 or $1,000, depending on the bank, allowing consumers to borrow as much as they would from a payday lender, but at a much lower cost and with strong guarantees. Payday loans typically carry interest rates over 300% and often feature unaffordable lump sum payments that can eat up a large chunk of borrowers’ regular paychecks. In most cases, repeated use results in borrowers carrying costly debts for several months.
Although banks use different criteria to determine eligibility for small dollar loans, the top four that offer them – Bank of America, Huntington, US Bank and Wells Fargo – primarily base their qualifications on the customer’s account history. with them ; for example, if the potential borrower has been a customer for a number of months, regularly uses the checking account or debit card, or has direct deposit for paychecks. The 12 million Americans who use payday loans each year have a checking account and income, as these are the two requirements for getting a payday loan.
Large banks offering small loan amounts charge prices at least 15 times lower than average payday lenders. The loans are repayable in three to four months, which corresponds to consumers’ opinion of the time required to repay small loans. Compared to typical payday loans, which keep borrowers in debt for an average of five months of the year, consumers can save hundreds of dollars by using loans from banks instead. For example, the average cost to borrow $400 for three months from a payday lender is $360; meanwhile, these banks charge $24 or less for this credit. Similarly, the average cost to borrow $500 for four months from a payday lender is over $500 in fees alone, while the cost of borrowing through one of these banking programs is, at most, $35.
Previous research has shown that using payday loans can put customers at greater risk of losing their checking accounts, suggesting that borrowers of small bank loans may reap benefits beyond saving hundreds of dollars. dollars in fees. And because the average payday loan borrower makes about $30,000 a year, or less than $1,200 per paycheck every two weeks, the total savings would be substantial.
When Pew surveyed payday loan borrowers, 8 in 10 said they would borrow from their bank if it started offering small loans and they were likely to be approved. Their main criteria for choosing where to borrow included how quickly the money would be available, how certain they would be of being approved, and how easily they could apply. Banks all have quick and easy online or mobile applications and place loan proceeds in customer accounts within minutes. It’s much faster and easier than any payday lender’s process. This speed and ease suggests strong customer acceptance of small bank loans.
Checking account customers who turned to payday lenders and other high-cost lenders because their banks didn’t offer small loans now have a far more affordable option than any that were widely available. These new small loans are now an option partly thanks to well-designed advice from the Federal Deposit Insurance Corporation (FDIC), the Federal Reserve Board of Governors, the Office of the Comptroller of the Currency and the National Credit Union Administration who welcomed the automation of this type of lending and gave banks the regulatory certainty they needed to develop these products.
So far, only Bank of America, Huntington, US Bank and Wells Fargo have stepped up to offer secure, low-payment loans or lines of credit to their most-needed customers who would not normally qualify. to bank loans. Several other institutions have announced that they are developing new small loan products. To reach millions of borrowers and help them save billions of dollars a year, compared to what they owe to payday lenders, more banks need to prioritize financial inclusion. To do this, they should join these four in offering similar credit to their customers who need the most help.
Alex Horowitz is a Principal Officer and Linlin Liang is a Senior Associate of The Pew Charitable Trusts Consumer Lending Project.