Small Dollar Credit Position Statement
March 2015
Since their establishment, credit unions have worked to promote fairness, thrift and opportunity. Community development credit unions (CDCUs) were organized by and for low-income and historically underserved communities to provide access to safe and affordable credit. One could argue that consumer protection is baked into our DNA.
As the Consumer Financial Protection Bureau (CFPB) continues to develop further regulations that will impact consumers and lenders, the credit union movement is encountering a moment of soul-searching. The fundamental question being asked is how to strike the balance in service to our members and sustainability of our institutions with the need to curb predatory lending practices. CDCUs, that have always strived to be vanguards in service and mission, are similarly struggling to define a rational position. Though all credit unions seek to strengthen their members’ financial health and to do no harm, we recognize there is a place for well-designed rules and regulations, even for the best behaved institutions. The challenge is to ensure those rules and regulations are relevant, effective, and entail minimal compliance costs.
The National Federation of Community Development Credit Unions supports the CFPB’s efforts to curb the widespread, predatory practices in short term, small dollar lending that drain wealth from low-income families and communities. We have worked with our national network of over 200 community development credit unions (CDCUs) and consumer advocate partners to offer the following CDCU principles on responsible small dollar lending and policy recommendations to address predatory practices.
The Federation's Guiding Principles on Small Dollar Credit:
- Household budget shortfalls cannot be solved with credit. There is considerable research to show that demand for predatory small dollar loans is driven not by one-time emergencies (car repair, one time unexpected bill, etc.) but rather by systemic income shortfalls to cover regular expenses. The public policy solutions to that challenge must include higher wages and a stronger social safety net, not credit.
- The usurious pricing of predatory payday loans is among the most problematic features of this type of lending. Triple-digit APRs create debt burdens that borrowers are often unable to get out from under. Price caps on small dollar loans must also be part of the public policy approach to creating a responsible small dollar credit marketplace.
- Credit unions (and particularly CDCUs) exist to promote thrift and the financial security of their members. Access to productive credit that increases financial security and promotes positive credit histories is fundamental to that work.
- CDCU lending has always hinged upon knowing community and members and tailoring viable products that meet demand not recognized by other lenders from outside these communities. CDCUs take risks other lenders won’t take, when they believe that the activity will improve the member’s financial position without undue risk to the institution. A fundamental principle of responsible lending is ensuring that the borrower has the ability to repay.
- Regulating consumer services is important and consistent with the principles of the credit union industry. But well-meaning rules, while needed in the broader industry, sometimes place heavy burdens on the very credit unions that are working hardest to promote the financial stability of American families.
Our Small Dollar Credit Policy Recommendations:
- Small dollar loans must be underwritten based upon the borrower’s ability to repay the loan while meeting other expenses, not on collateral requirements such as post-dated checks. Predatory payday loans have several elements that undermine the incentive that responsible lenders have to ensure proper underwriting. The high rate, short term, balloon payment structure, and preauthorized repayment device all contribute to a product that is high-cost and often unaffordable for the borrower, and yet ensures that the lender will be repaid. As lenders serving low income and immigrant communities, CDCUs have developed flexible yet responsible ways to confirm ability to repay, particularly for members who do not have traditional documentation of income. We urge the CFPB to preserve flexibility in any ability to repay standard, and we would be happy to share our expertise in this regard.
- Responsible small dollar loans provide borrowers with sufficient time to repay. The very short term of most payday loans contributes to their unaffordability and to creating a cycle of indebtedness. Numerous studies, including by federal regulators, show that small dollar loans perform best when they are underwritten to ensure ability to repay and when the term of the loan is extended to several months.i
- Rollovers associated with high fees hurt the consumer and weaken the institution and its mission. Predatory payday lenders’ reliance on repeated rollovers (i.e. nonpayment and continued indebtedness by borrowers) is widely regarded as one of their most unscrupulous practices.
- Front-loading of interest and fees should be prohibited so that unscrupulous lenders cannot drive up costs through frequent refinancing.
- Rules should mandate maximum transparency, so that borrowers know clearly the cost of borrowing before taking a loan.
- There should be safeguards against deferred presentment and automatic debit practices that result in pyramiding of fees and/or inability of borrowers to pay other bills. Rules should prohibit lenders from requiring that loans be secured by a post-dated check, the electronic equivalent, or other automated repayment methods.ii
i Federal Deposit Insurance Corporation. “A Template for Success: The FDIC’s Small-Dollar Loan Pilot Program.” FDIC Quarterly 4.2 (2010) https://www.fdic.gov/bank/analytical/quarterly/2010_vol4_2/FDIC_Quarterly_Vol4No2_SmallDollar.pdf
ii All credit unions carry out their small dollar lending without requiring preauthorized transfers in accordance with federal regulation 12 CFR 1005.10.