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“Safer” Loans for Payday Borrowers
In contrast to high-cost payday loans – where the finance charges typically translate into annual interest rates of 400 percent or more – these new loan options are less costly for borrowers (while still profitable for lenders) and won’t trap households in a spiral of debt. Many of these options also promise to help borrowers build credit and even save.
In the town of Cuyahoga Falls, Ohio, for example, city employees are now receiving an unusual benefit: the ability to borrow up to $3,000 in advances against their future pay. Workers who take out a loan have up to a year to pay it back, and the payments are automatically deducted from their paychecks. The annual interest rate is 24 percent.
This new employer-sponsored loan benefit, called “TrueConnect,” is the creation of Employee Loan Solutions, Inc. (ELS), a three-year-old California-based start-up founded by three former employees of the in-house product innovation unit at Intuit, the makers of TurboTax. ELS Co-founder Doug Farry says his company is now working with several dozen employers in four states and reaching roughly 10,000 workers nationwide.
Farry, who also helped launch the Coalition for Safe Loan Alternatives, says his product includes several features to ensure that borrowers don’t get caught in the cycle of debt for which payday loans are notorious for perpetuating. According to the Pew Charitable Trusts, many payday borrowers end up renewing their original loans repeatedly or taking out new loans to pay back old ones. The average payday borrower, Pew finds, takes out eight loans a year and spends more on paying interest than on paying back principal.
Farry’s customers, on the other hand, can’t borrow more than what they can pay back with 8% of their paycheck. “It’s pretty conservative,” says Farry. “We want 92 percent of their pay to be available for a rent payment, a car payment, medical insurance and other day to day expenses.” Moreover, Farry says, on-time payments are reported to credit bureaus so borrowers can build up their credit scores.
Victor Pallotta, the Cuyahoga Falls City Council member who led the effort to bring this program to city employees, says the loans are meant to tide over workers with short-term cash flow problems or an unexpected financial emergency. But he also hopes to divert as many customers as he can from the hundreds of high-cost payday and car title lenders doing business in his state.