Just because your bank may start to offer this service, it doesn’t mean you should use it.
Earlier this year, the American Bankers association asked federal regulators to ease rules related to “small-dollar lending.” The goal is to bring back a customer service known as direct deposit advance. It’s a short-tell installment loan that allows you to borrow quickly by getting around underwriting rules. However, consumers need to be aware of the risk of using financing options like these, because they can be just as dangerous as payday loans.
What is direct deposit advance?
Direct deposit advance is essentially a payday loan through your bank. You effectively borrow money against your income. That’s how you get around basic underwriting rules. It’s basically an agreement that you get a small amount of money now that you pay back as soon as you get paid.
Banks offered direct deposit advances before, prior to 2013. As long as you had direct deposit set up with a bank, you could borrow up to a certain amount. However, federal regulators stepped in by 2013 to curtail the use of these products. Several different agencies placed restrictions: the FDIC, Office of the Comptroller of Currency, and the Consumer Financial Protection Bureau.
Now banks are asking these agencies to walk those restrictions back. However, consumer advocates argue that the direct deposit advance carries the same risk as payday loans. Because qualification only considers income and not expenses, it doesn’t factor in the ability of the consumer to repay the loan.
Why is direct deposit advance bad?
Interest rates on financing are correlated to the convenience they offer. Secured traditional loans that have collateral offer the lowest rates. Unsecured loans have higher rate and open credit lines like credit cards are still higher. No-credit-check loans that skip the underwriting process offer the ultimate convenience, but that comes at a price. Namely, the interest charges that can be over 300%.
The other reason these loans are risky is because skipping underwriting means the lender doesn’t assess your ability to repay. They never look at your other debts or expenses to see if you can afford to pay the loan back.
As a result of these two factors, people who shouldn’t borrow at all wind up with 300% APR loans. The argument is that if you use a short-term installment loan correctly, you never pay that 300% APR. Most of these loans, including direct deposit advance, have 2-week terms. The APR isn’t applied if you pay the loan back in-full within that two weeks.
However, there is nothing in place to make people use these loans correctly. In fact, studies show that most people that take out these loans do so because they have extreme financial distress already. They can’t qualify for a traditional loan, they’ve maxed out their credit cards, so they turn to the only financing they can qualify for – one that requires no credit check.
What’s the alternative?
“If you don’t have reasonable expectation that you can pay any short-term financing like this back within the first billing cycle, don’t use it,” advises Gary Herman, President of Consolidated Credit. “Payday loans and direct deposit advances cannot keep you afloat if you can’t afford all the expenses in your budget. If you use them for that, you end up with serious debt problems – more serious than what you already face.”
Herman advises anyone who is considering any type of short-term financing to consider two things:
- Make sure you have the right need
- Absolutely ensure you have the ability to repay it in the short term
“Using financial products like these as a stopgap for your budget is a recipe for disaster,” Herman explains. “Instead, you need to find a long-term solution for your budget that focuses on eliminating the debt you already have.”
In many cases, the better option is to consolidate the debt you already have in order to fix your budget. Debt consolidation allows you to combine multiple debts into a single low-interest monthly payment. Since this reduces the interest charges, you can get out of debt faster even by paying less money each month. This gives you the breathing room you need in your budget to break your credit dependence.