See also Kai Wright’s feature story in this issue, “How Payday Lenders Evade Regulation.”
Payday lenders aren’t welcome in Maryland. More than three decades ago, the state’s legislature placed a hard 33 percent interest rate cap on loans smaller than $6,000, in effect banning the predatory practice that has bilked billions from low-income borrowers across the nation. But although Maryland legislators have consistently fought to preserve usury protections, they haven’t found a way to erase demand for financial instruments like short-term emergency advances or check-cashing services, which provide immediate relief at an excessive long-term price.
According to a recent survey conducted by the Corporation for Enterprise Development, 25 percent of Maryland’s female-headed households and 29 percent of minority households are “asset poor,” meaning their total savings can’t cover basic expenses for three months. The median amount of revolving credit card debt per borrower is $3,391, the fifth-highest rate in the nation. And 22 percent of all Maryland households lack a simple checking or savings account. With no cash in reserve, these Marylanders find that a car repair or medical bill can drive them into financial ruin.
This dynamic troubled a group of Baltimore community lenders, who met in 2007 at the behest of Joan Lok—a community affairs specialist with the FDIC—to develop a low-cost loan product targeted at the unbanked. From those discussions emerged Borrow and Save, a program that offers residents emergency credit—between $300 and $1,000—at 7.99 percent interest (far cheaper than payday loans or most credit cards), so long as borrowers participate in one financial literacy course and have a savings account.
In the past eighteen months, officials at Neighborhood Housing Services of Baltimore, a nonprofit that administers the program, have distributed 107 loans to folks desperate for a modest capital infusion, from a grandmother in need of school supplies to clients facing steep winter utility bills. Initially limited to five zip codes on Baltimore’s Southeast Side, Borrow and Save is now available citywide and could expand into the surrounding county in the future. At first lenders saw relatively high default rates—around 20 percent. After a few months, they tightened borrowing guidelines slightly and required that borrowers attend a four-hour financial literacy class before they were given their check. They were able to cut the default rate in half, which is in line with other types of unsecured credit, according to the FDIC.
Although Borrow and Save is one of the more sophisticated examples, similar small-dollar loan programs have sprouted in patches across the country. Last summer the FDIC completed a two-year pilot program with twenty-eight community banks that have started offering affordable loans with similar terms. According to Rae-Ann Miller, who coordinated that study, plenty of other local lenders carry comparable loans, even if they aren’t explicitly designed or marketed as payday loan alternatives.
On their own, these products are too small to generate huge profits for banks or credit unions. But FDIC researchers found that with sound underwriting and committed customer service, banks can keep delinquency rates in check and establish long-term relationships with this untapped market of borrowers, an appealing prospect at a time when revenue for all financial institutions is shrinking.
Since the pilot wrapped up, Miller and her colleagues have been studying ways to scale up these practices, including models in which loans are delivered through the workplace as an employee benefit. Democrats have already slipped a provision into the financial reform package that provides economic institutions with incentives to parcel out low-cost loans to 19 million unbanked Americans. And consumer advocates are lobbying Community Reinvestment Act examiners to give small-dollar loan programs outsize value in their compliance evaluations.
For banks trying to restore consumer trust in the wake of a greed-fueled economic crisis, it’s an opportune time to experiment with these socially responsible lending models. And let’s face it—given the state of the economy, potential clients aren’t in short supply.