Is Bad Credit Financing Designed to Fail?

Lenders and brokers who loan money to people withand you have sufficient funds for all but one of them,
lower incomes and spotty credit will all claim that theythe bank will clear the largest dollar amount check first,
provide a valuable service to a community that isensuring that the other two smaller checks will
under-served by traditional lenders. But do they really?overdraw your account, thereby allowing them to
Or are they instead exploiting the plight of our mostcollect two overdraft or NSF fees instead of just one.
vulnerable citizens by promoting an endless cycle ofUnfortunately, this practice remains legal.
debt and making a killing off the interest and other feesPrepaid Debit/Credit Cards
they charge?Prepaid debit or credit cards are marketed to the
While it is a good idea to give people who might notunbanked as a way to access their money more
normally have the access to financing a leg up, surelyconveniently and safely as well as do things like shop
that leg up should not also come with a heavy weightonline. Prepaid cards are easy to get as the only thing
attached to it in the form of draconian and exoticrequired is cash with which to load the card.
terms that make it close to impossible for theHowever, the convenience and added safety come at
borrower to successfully meet his obligations.a steep price; often much higher than the fees
Payday Lendingnecessary to maintain a bank account would be.
Payday lenders love to claim that they are providingDepending upon the card, monthly maintenance fees
an essential service to those who might otherwise beare required, which can range as high as $10 a month.
unable to borrow money in a time of need. TheIn addition to maintenance fees, the cardholder is
concept is relatively simple: the payday lender loanscharged every time he or she uses it. There are
the borrower, frequently a member of the workingcharges for point-of-sale ATM transactions, charges
poor or living on a fixed income such as disability orfor credit transactions, charges to withdraw money,
social security benefits, a small amount, usuallycharges to check the balance,charges for loading the
between $300 and $500. To secure the loan, thecard, and even inactivity fees.
borrower writes the payday lender a personal checkFor the people to whom these cards are marketed,
for the amount of the loan and the fee. On theevery dime counts and using these cards often
borrower's next payday, the lender cashes the checkcauses a slow bleed of cash that can be
and gets paid back.devastating.More disturbingly, more states are requiring
That doesn't sound so bad, right? It sure is nice that itsthat benefit checks such as unemployment and public
available if you have some unexpected expense likeassistance be paid through prepaid debt cards instead
your car breaking down or if you're unable to coverof via check. Social Security will be offering this as
that higher than normal power bill. This is the paydaywell, although at this writing, it is not a requirement.
lending industry's argument. If they weren't there, well,Subprime Mortgage Loans
poor and moderate income Americans would haveIn the last number of years, about the last twelve or
nowhere to turn for the cash they need, and if usedso, a new breed of lender and a new kind of loan was
responsibly, the fees are marginal.created. This type of lender and loan were was
As is the case with most financing targeted at lowersupposed to unlock the housing market to groups
income families and those with marginal credit, thepreviously locked out: those with lower incomes and
terms of these loans are such that they become veryspotty credit histories. The so-called subprime loan
difficult to pay off and the debt trap closes. To beginwas born. The fact that the terms of these loans
with, the interest rate on them, when expressed on anwere often so bad, and so expensive as to render
annual basis, is often in excess of 400%, makingthem doomed to failure from the beginning was
payday loans among the most expensive type ofwashed away with assertions by the brokers who
financing available. In addition, because the term of thesold them and the lenders who made them that the
loan is very short, one to two weeks, and because theborrower could always refinance into something better
entire loan must be repaid all at once, most paydayin the future, "after their credit improves."
loan borrowers often must get a new loan, for anEvidence now suggests that the industry point of view
additional fee, to cover the first one. This cyclewas at best misguided and at worst downright
continues repeating until the borrower has paid feespredatory. In recent testimony before the the FCIC,
more than double the amount of the original loanJulie Gordon of the Center for Responsible Lending, a
without having touched the principle.non-partisan, non-profit group, revealed some shocking
In fact, over 90% of payday loan revenue comestruths regarding subprime lending:
from recycled loans. Payday lenders know that theFirst, these loans were engineered, primarily and in all
people who get these loans will be unable to pay themaspects, to make the most money for mortgage
back when due and will have no choice to but to rollbrokers, lenders, servicers, and investors. With yield
them over into a new loan.spread premiums to reward brokers for making
The payday lending industry can do all of the things itsubprime loans and with Wall Street itchy for more
does because is it is largely unregulated and is fightingloans to bundle off into Mortgage Backed Securities, it
tooth and nail to remain so. Alan Jones, the owner andwas all about making money now, and since these
CEO of one of the larger payday lending companies,actors didn't hold the mortgages they made
has even gone so far as to claim that payday lendersthemselves, the risk was passed on to the next guy.
live in poverty and therefore shouldn't be regulated.Second, far from helping lower income families and
This is a guy with a net worth of over half a billionthose with lower credit scores obtain access to
dollars and a regulation size football field, complete withfinancing that they didn't have before, it placed them at
stands and lights, in his backyard.a strong disadvantage to be able to pay these loans
Overdraft And NSF Feesback from the very start. Empirical evidence gathered
As the cost of living has continued to skyrocket and inin a 2008 study found that borrowers with similar risk
the absence of growing incomes, people have comeprofiles, in other words, with similar credit scores and
to rely on overdraft coverage as a source of credit.incomes, whether they were low, middle, or high
The problem with this is that like payday lending, it is aincome borrowers, were more than five times as likely
wealth stripping exercise and next to payday lending,to default on a subprime loan as compared with a
among the most expensive forms of credit you canprime loan with reasonable rates and repayment
get.terms.
For example, if you have $5.00 left in your bankFurthermore, 61% of borrowers who were put into
account and you use your ATM card to buythese risky loans could have qualified for prime loans
something that costs $6.00. Your bank will allow thewith conventional repayment terms. However, it was
transaction to go through and charge you $35.00 formore profitable to place people into these exotic loans
the $1.00 of your overdraft. So now you're in the redwith terms that even financial experts would
by $36.00, for $1.00 of credit advanced to you "as athemselves have a hard time understanding, let alone
courtesy."the borrower.
Of note, recent changes to the laws governingLastly, far from expanding homeownership, 90% of the
overdraft charges will require that banks get yourmortgage loans made in the period of 1998 to 2006
permission, in the form of an opt-in, for overdraftwent to families who already owned a home: 60%
protection and fees. This only applies to ATM charges,were refinances and the other 30% went to families
not to checks, and does not cover non-sufficient fundsmoving from one residence to another.
charges.Far from helping people who would otherwise not
70% of bank income is now from overdraft andhave access to financing enter our financial system
non-sufficient funds fees. In 2008 banks charged theirand prosper, bad credit lending all too often leads to
customers $34.3 billion dollars in fees, most of this fromborrower default and failure. This failure is not the
people who have overdrawn their account more thanresult of their inability or unwillingness to pay as agreed,
once. In fact, 20% of US bank accounts generate 80%but is instead a function of the financing terms
of overdraft fee income.themselves.
Another egregious practice used by the banks toThe bottom line in financing should be that if you can't
maximize their overdraft and non-sufficient funds feegive someone a loan with a fair interest rate and
income is the re-ordering of check-clearing from theterms, then perhaps you shouldn't be making the loan
highest dollar amount to the lowest. This means that ifat all.
three checks are presented to your bank for payment