Banks' version of payday loans can also trap borrowers in a costly cycle of debt

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Boston Globe
By: Candice Choi
August 24, 2011

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 are quick to distance themselves from the payday lending industry. But consumer advocates say these direct deposit loans - as banks call them - bear the same predatory trademarks as the payday loans 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, 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 loans are different because they come with safeguards.

Wells Fargo, for example, notes customers can borrow only up to half their direct deposit amount or $500, whichever is less.

Its fees are cheaper too, at $7.50 for every $100 borrowed, though that still amounts to a 261 percent annualized interest rate. The amount of the advance and the fee are automatically deducted from the next direct deposit.

Wells Fargo admits it's an expensive form of credit. But customers can max out their loans continually for up to six months before they are cut off. Then after a one-month "cooling off'' period, they can resume taking advances.

US Bank and Fifth Third Bank 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 at the Center for Responsible Lending, an advocacy group. "They call them short-term loans, but that's just not how they're used. And banks know that.''

Even if customers can borrow only half the amount of their next direct deposit, that can be a significant setback if they are living paycheck to paycheck, King says. They'll probably need another loan to cover 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.

Another concern is that direct deposit loans are tantalizingly easy to access. 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.

Candice Choi writes for the Associated Press.

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