Payday loans were supposed to disappear from Arizona in 2010, when a 36 percent annual-interest-rate cap went back into effect - but lenders are finding new ways to charge rates of up to 400 percent on small loans.
Two of the state's major national banks offer "advances" on their customers' direct deposits that are similar to payday loans, consumer advocates say. A study by the Center for Responsible Lending concluded that the typical annual percentage rate charged on these "bank payday loans" is 365 percent.
Another Arizona lender, CheckSmart stores, is offering lines of credit and overdraft protection to purchasers of prepaid debit cards. Those relatively complicated loans charge fees and interest that can add up to an annual interest rate of about 400 percent.
Finally, a company called Cash 1 LLC agreed last month, after being sued by the Arizona Attorney General's Office, to stop selling gift cards to large retailers with a credit option that charged a typical annual rate of about 360 percent.
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All these options can lead consumers into the trap of taking out repeated loans, as they take a loan to cover one expense, only to find that the next paycheck is now too small to cover the next bills, said Kelly Griffith, co-director of the Tucson-based Center for Economic Integrity.
"They get caught in the same debt trap mentality, which is great if you're a lender because you make a lot of money out of it," she said.
Some customers note, however, that the services are useful especially in emergencies, even if expensive.
"It has met my objectives, financially, but it's not the cheapest route," said Tucson CheckSmart customer Karla Decker.
Before 2010, a customer such as Decker might have ended up with a payday loan, paid for with a postdated check, but in 2008 Arizona voters rejected a measure that would have allowed payday loans beyond July 1, 2010. In 2010, the Legislature, too, declined to help the industry and let the pre-existing 36 percent cap go back into place.
Griffith of the Center for Economic Integrity was among a nationwide group of consumer advocates who wrote Thursday to Thomas Curry, the U.S. comptroller of the currency, asking him to intervene against CheckSmart's partner in the prepaid-card loans, Urban Trust Bank, whom his office regulates.
"CheckSmart is using Insight (brand) prepaid cards to make loans in Arizona and Ohio that exceed the usury rates in those states," the group wrote. "The CheckSmart/Urban Trust Bank partnership, used to facilitate payday loans in states where the loans are not permitted, is an abuse of the national bank charter."
2 Banks offer loans
Wells Fargo and US Bank offer advances to customers who have regular direct deposits, whether they're from a paycheck or Social Security benefits. Wells Fargo, Arizona's top-ranked bank by deposits, charges a 7.5 percent fee on its "Direct Deposit Advance," and US Bank, which ranks ninth in the state, charges 10 percent on its "Checking Account Advance."
At both banks, the loan and fee must be paid back out of the customer's next direct deposit, within at most 35 days. At US Bank, it will be taken out even if that causes an overdraft, accruing more fees for the customer.
Representatives of both banks deny the loans are similar to payday loans, noting that the advances are only for their customers, whom they warn that these programs amount to expensive credit and that alternatives may be available.
"This is designed for an emergency situation. It's expensive," Wells Fargo spokeswoman Richele Messick said, adding, "It's less expensive than a payday loan."
However, consumer advocates say that's a distinction without much difference. A 2011 study of 55 "bank payday loan" customers by the North Carolina-based Center for Responsible Lending, which included customers of banks other than Wells Fargo and US Bank, showed that customers took an average of 16 of these loans and stayed in debt for 175 days per year. Their loans averaged 10 days and annual interest rates of 365 percent.
While banks tout the fact that they only market this service to their own customers, Griffith said that's a danger.
"It's a little more disconcerting in that the bank has direct access to the bank account, and the bank gets paid first, as opposed to any other bills, any other creditors," she said.
Source of Earnings
The banks' reason for offering these and other non-traditional products is apparent, said Anand Bhattacharya, a professor of practice in the finance department at the W.P. Carey School of Business at Arizona State University.
"Given regulatory pressures, given a weak economy, given the fact that rates are low, there is pressure on bank earnings," Bhattacharya said. "You're being asked as a consumer to pay for a service that costs money."
One of the key changes has been the passage of the Dodd-Frank financial-reform law, which limited banks' ability to impose high overdraft fees to customers and big debit card fees to retailers. Fiserv, a company that sells software used by banks for making direct-deposit advances, says that's one of the reasons it developed its so-called "Relationship Advance" software for banks.
"Consumers can be offered a product that meets their liquidity needs, and their budget constraints, while banks are able to provide a valuable service that generates a new and diverse revenue stream to partially offset government proposed overdraft and credit card changes," Fiserv executive Jeff Burton said in a 2009 announcement of the program.
While the advances may rack up fees that far exceed the state's 36 percent cap on annual interest rates for consumer loans, they are not violating state law. The Arizona law does not apply to federally regulated banks.
Found a Workaround
State law does apply to CheckSmart stores, but parent company Community Choice Financial Inc. acknowledges in a recent filing with the U.S. Securities and Exchange Commission that it has found a workaround of the state's 36 percent cap, as well as Ohio's 28 percent cap.
"In most cases, our lending companies make short-term loans without any involvement of either affiliated or unaffiliated third parties. In Ohio and Arizona, however, our customers receive financial services through us from multiple parties," the company said in an April 25 filing preparing for its initial public offering of stock on May 8.
In practice, what this means is that holders of CheckSmart's prepaid debit cards may be able to sign up for a credit line, but that money would formally be loaned by an outside bank, consumer advocates said in their letter to the comptroller. The result: CheckSmart charges a 14 percent fee on its advances, and the outside bank charges the customer 35.9 percent - just under Arizona's cap - on both the fee and the principal, all of which come out of the customer's next direct deposit to the card.
"While we believe that these multiple-party programs are lawful, they entail heightened legal risk when compared to single-party loan programs," the company warns potential investors in its filing.
Tucson customer Decker, 35, said she was in financial trouble last August when she lost her credit-union checking account and turned to CheckSmart for check-cashing. The employee patiently talked her through the options and recommended the prepaid debit card. Decker bought it and added the credit-line option, she said.
Over the last eight months, Decker said, she's used the credit line about six times. Once she used the service in back-to-back paychecks, when paying off the first loan meant she didn't have enough money to pay all her bills out of the next check, she said.
"It has saved me from many financial events that I wasn't expecting. That was the only source of extra income that I had," said Decker, but she added she's improved her financial situation and is trying to return to a traditional checking account.
State Rep. Debbie McCune Davis, a Democrat who led the drive against payday lenders in 2008 and 2010, said via email these cards are "clearly a workaround."
"It is my opinion that several payday lenders are waiting for an opportunity to re-enter the Arizona market," she said. "They disregard the will of the people, as reflected in the 2008 vote, and want to return to their predatory practices."
How the different loan products work
Traditional payday loans went extinct in Arizona in July 2010, when a previous 36 percent cap on annual interest rates for consumer loans went back into effect. Here's how payday loans worked, compared with two similar programs being offered now.
1. Storefront payday loan
The customer provided the lender a postdated check for the amount loaned, plus a fee. For example, the customer may have written a check for $200, plus an agreed-upon fee of 15 percent, or $30, for a total of $230.
The lender provided $200 in cash to the customer.
In an agreed-upon term, often two weeks, the lender took the principal and fee from the customer's checking account.
In many cases, customers were unable to repay the loan at the end of the term. The lenders often would "roll over" the loan, for an additional fee, meaning customers continued to pay regular, large fees on the same original principal.
The fee paid on the initial, two-week loan in this case is equivalent to an annual interest rate of 390 percent.
2. Bank advance
Only existing bank customers with regular direct deposits, be they paychecks or benefit checks such as Social Security, qualify for these loans.
The bank advances the customer up to $500 and charges a fee of between $7.50 and $10 per $100 advanced. The entire principal and fee are taken out of the customer's next direct deposit at some banks even if that results in the account going into overdraft and accruing more fees.
The bank will not "roll over" the initial advance but will issue a new loan with the same fee after the first loan is paid off, though some banks limit the number of consecutive loans.
If a customer takes a $200 advance, accruing a $20 fee, and repays it in two weeks, that amounts to an annual rate of 260 percent.
3. Prepaid card
CheckSmart stores in Arizona are among many that sell prepaid debit cards - cards that you purchase by putting a certain amount on the card and paying a fee for the card. However, CheckSmart also offers two credit options for Arizona card users who make regular direct deposits to their cards, consumer advocates say.
Line of credit
The customer sets up the line of credit in advance, then pays $14 for every $100 cash borrowed. In addition, the outside bank that lends the money via CheckSmart, also charges 35.9 percent interest. The principal, fee and interest are taken out of the customer's next direct deposit.
Under this system, a 14-day loan of $100 would cost $15.38, or an equivalent of a 401 percent annual interest rate.
Overdraft
Customers with direct deposits to their prepaid card may also set up an overdraft protection service. The charge is 15 percent of the negative balance up to a maximum of $36 in fees, and the principal and fees are paid with the next direct deposit. Over two weeks, the 15 percent rate charged works out to an annual percentage rate of 391 percent.
Contact reporter Tim Steller at 807-8427 or tsteller@azstarnet.com