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Payday lender replacement?
One of the most frequent questions payday lending opponents get from legislators about eliminating the industry is, "How will people using payday lenders get short-term loans?"
The industry argues that people will bounce checks, go to other states or turn to unregulated online payday lenders. But after North Carolina banned payday lenders last year, the state's credit unions stepped up, and a new study from Virginia's neighbor shows that residents didn't miss the lenders or lose access to short-term credit.
In Hampton Roads, the lenders have now set up in every major shopping center in the busiest corridors as the industry has grown since 2002 into a $1 billion business in Virginia. As banks have resisted offering payday alternatives, citing other credit products they already offer, the three largest Peninsula credit unions have stepped up with successful programs.
The fight over possibly banning payday lending will be at the forefront of the Virginia General Assembly again in 2008. The payday industry and its supporters say they fulfill a short-term financial need shunned by mainstream lenders. But the local credit unions have discovered they can build loyalty and create long-term value by offering the loans to their customers at lower interest rates, along with financial counseling.
"We knew going in that this wasn't going to be a money-making product, but would have a far-reaching effect," said John Sargent, vice president of lending at 1st Advantage Federal Credit Union.
Bayport Credit Union, formerly Newport News Shipbuilding Employees' Credit Union, launched an alternative to payday lending this spring. Langley Federal Credit Union has had a small loan program since 2004, and 1st Advantage started the small loans in 2006.
The credit unions charge about $5 for a $500 loan, rather than the 390 percent interest charge of $75 the payday lenders charge for a $500 two-week advance. None of the credit unions expect to make any money on the loans, but they do hope to break even and see it as a necessary service for members.
"There had been a rise with our members getting in trouble with payday loans, and we had to do something to help our members," said George R. Dudley Jr., Bayport's chief executive officer.
Credit unions are not-for-profits, and their customers are members who control the company and its board of directors. The three largest on the Peninsula can serve anyone in the region. Because their goal is helping members - whereas banks must maximize profits for shareholders - they can invest money in these payday programs.
"We've already seen several members that we've really helped," Dudley said. "We've gotten them out of this vicious cycle and gotten them back on track."
A study released this month by the University of North Carolina for that state's banking commission concluded that residents didn't miss payday lending after it was banned in 2006. The survey said people were glad they were closed, and still able to find credit when they needed small loans.
Of the 400 low- to middle-income North Carolinians polled, 159 had a recent crisis that required them to access more money than they were paid. The top reasons for the need were similar to what payday lenders say drives customers to them, including medical or car problems, job loss or home repairs.
Few of those people used payday lenders during crises over the last three years, and had opted for other types of loans or credit from financial institutions, friends and family or churches. Many used multiple sources other than payday loans to meet short-term needs, which may explain why so few missed the lenders after they left.
The study involved two focus groups with 10 former payday loan borrowers in each group.
When compared to banks or credit unions, payday lenders had some advantages that people in the focus group liked. In the North Carolina focus groups, customers said they didn't think traditional banks would make the small loans and that payday loan employees remembered their names and didn't look down on them like they felt bank workers did.
That's why local credit unions have branded and marketed their payday alternative programs. Tellers are trained in how to promote the program to customers who are using the loans.
"The fact that we have it and market it, we're saying, 'Hey, it's OK,'" Dudley said.
The North Carolina study also showed that people like the speed and ease of a payday loan. They can do it without undergoing a credit check, or a default being reported to credit bureaus. The credit unions have also tried to develop speedy turnaround, but borrowers are strongly encouraged to use the free counseling at the credit unions.
At Bayport, classes are regularly taught by Sylvia Sutherland. She helps people compose themselves, see that others are in the same situation and attack the roots of their debt problems methodically. She teaches them to save, budget and spend more wisely and understand their credit reports.
"When people are facing a crisis, they're more open to solutions," Sutherland said.
North Carolina's State Employees' Credit Union, the nation's second-largest, stepped up with a new 12 percent interest loan product in 2001, when the state first began phasing out payday lenders. After five years, the default rate has been less than half of 1 percent. The credit union requires its members to put 5 percent of each loan in savings, and members have saved $8 million.
First Advantage has the same requirement in Hampton Roads, and charges 17.95 percent interest on loans up to $500. The Bayport program has opened $684,000 in credit lines for 1,790 customers, and none have defaulted yet.
Payday lenders have long said they can not cover their costs and make a profit at a 36 percent interest rate, the typical ceiling for every other lender. The North Carolina study says that may be true, but it makes more sense for a bank or credit union to include the loans as part of a business model that includes a larger pool of loans.
The North Carolina study found people will often knowingly bounce a check when they have short-term cash needs, and they get mad over the fees - which payday lenders point out can be higher than payday loans. At the national average overdraft fee of $27.40, bounced checks made out to payday lenders in Virginia in 2006 brought banks $4.2 million in fees.
The Community Financial Services Association of America, the payday lending trade group, says the end of the industry in North Carolina produced a windfall for the state's banks and credit unions. The group says credit unions reversed three years of declining amounts of bounced check and overdraft protection fees in 2006.
The credit unions are not required to make a profit on bounced check fees and charge less than banks. The fees are still much lower than the $53 in interest paid on average Virginia payday loan. That interest continually piles up as new loans are used to pay off the principal of old loans and a short-term problem becomes long-term.
In Virginia, 67 percent of payday borrowers took out at least 13 loans in 2006. Sutherland says the people she counsels describe it as a web they can't escape. But more credit union customers are getting themselves out of their financial problems, and the institutions expect to become busy if payday lending is banned in Virginia.
"I hope so," Sargent said. "Education is a big part of what we do here. These aren't customers. These are members, and we hope to have them forever."