Choose your payday lender wisely

For the millions of Americans struggling to afford an unexpected expense, high-interest payday and online loans may seem like acceptable options despite the inherent risk.

But guidelines issued by federal regulators in the spring could bring a competitor to small-dollar lending: banks. The guidelines omit a previous suggestion from the Federal Deposit Insurance Corp. that bank loans should have annual percentage rates of 36% or less.

While some consumer advocates say a rate cap is necessary consumer protection, researchers say banks can check a borrower’s credit and offer affordable loans, which payday lenders whose APRs exceed often 300% generally do not.

If your only option is a high-interest loan from any source, take control by understanding the rate and monthly payments and choosing a lender who verifies your ability to repay.

Understanding your rate to calculate payment

There is no federal interest rate cap on small loans of a few thousand dollars or less, and banking regulators cannot impose one. But 45 states cap APRs on loans of $500, while 42 states have caps on loans of $2,000. Check the National Consumer Law Center’s fact sheet to see the APR cap in your state.

The NCLC advocates a federal rate cap of 36%. Associate director Lauren Saunders said without it, high rates could permeate other credit products. Many lenders who offer APRs of 36% or less tie your rate to the risk they are lending to you, based on your credit history. If you’ve had difficulty making loan or credit card payments in the past, the lender may consider you a high-risk borrower and rate you closer to 36%.

APRs are useful for comparing loan products, but seeing dollar amounts can help consumers gauge whether they can make the required payments on an installment loan, said Alex Horowitz, head of research at The Pew Charitable. Trusts.

If the only loan you can qualify for has a rate higher than 36%, calculating monthly payments can help you figure out what you can afford. A bank would have to charge $50 to $60 on a $400 loan paid off over three months to make it profitable, Horowitz said. That’s an APR of 75 percent to 90 percent. A 2017 study by Pew found that many consumers think it’s a fair rate.

Small-dollar lending is currently dominated by online lenders, said Leonard Chanin, assistant to the chairman of the FDIC.

But the US Bank’s “Simple Loan” offers a rare example. The loan typically has an APR of around 71%. Autopay borrowers pay a fee of $12 for every $100 borrowed and repay the loan over three months.

Chicago-based online lender OppLoans provides loans to borrowers with bad credit and has APRs of up to 160% in some states. CEO Jared Kaplan said it’s more expensive for his company to acquire and sign up customers, leading to higher rates.

“Whether (your APR is) 79, 99 or 160, you’re dealing with risky customers and the price should justify that risk,” he said.

Choose a lender who verifies your financial data

Lenders who don’t determine your repayment capacity using information such as your income, existing debts, and credit information tend to offer high-interest loans with short repayment periods. which makes them difficult to repay and locks you into a cycle of debt.

Banks and other lenders who can access your bank account information and payment history can determine whether you can afford the loan.

Simple loan applicants must have a checking account for six months and have direct deposits sent to the account for three months before they can apply, said Mike Shepard, senior vice president of consumer loans at US Bank.

This ability to underwrite an existing customer, rather than someone they don’t already know, helps make a bank loan affordable for consumers, Horowitz said.

Other Ways to Appraise a Small Loan

Along with low annual interest rates and a review of your repayment capacity, here are some things to look for if you need a high interest loan.

Full amortization: Monthly payments should repay both principal and interest on a loan. Interest-only payments do not reduce the principal of the loan, so interest continues to accrue at the same rate. Check the loan amortization schedule before agreeing to borrow.

Credit report: The lender must report your monthly payments to at least one – and ideally all three – of the major credit bureaus. If you make your payments on time, these reports can improve your credit.

No setup or prepayment fees: Origination fees, sometimes called administrative fees, and prepayment penalties help the lender make money, but they have little benefit for you.

Sally J. Minick