As the number of unemployed Americans soars because of the coronavirus pandemic, federal regulators are looking for ways to get cash into the hands of those who need it now. One new initiative: get more banks and credit unions to offer small personal loans at low rates.
Five federal agencies — the Federal Reserve System, Consumer Financial Protection Bureau, Federal Deposit Insurance Corporation, National Credit Union Administration, and Office of the Comptroller of the Currency — teamed up on Thursday to issue a joint statement encouraging financial institutions to "offer responsible small-dollar loans to consumers and small businesses in response to COVID-19."
The regulators said that banks and financial institutions could structure these new loans in a variety of ways, including open-end lines of credit, installment loans paid back over a set duration or single payment loans.
While regulators said that the loans should be offered in a way that prioritizes the "fair treatment of consumers" and is "consistent with safe and sound practices," experts say that Americans should research their options carefully before signing on the dotted line.
If you are considering taking out a loan to help bolster your finances amid the coronavirus pandemic, it's important to focus on not only who the lender is, but how the loan is priced and structured. For many borrowers, a single payment loan doesn't make sense.
"The guidance references single payment loans and that's really a euphemistic way of describing a payday loan," says Rebecca Borné, senior policy counsel for the Center for Responsible Lending.
While regulators want these loans to be responsible, they issued guidelines, as opposed to formal rules. Consumer advocates like Borné worry that big banks will use this as an opportunity to offer high-cost loans with APRs over 100% that may be little better than payday loans.
If that happens, it could be worse in some ways because banks control the consumer's bank account, Lauren Saunders, associate director of the National Consumer Law Center, tells CNBC Make It.
A payday loan is a small loan you can get in most states by walking into a store with just a valid ID, proof of income and a bank account. Unlike a mortgage or auto loan, there's typically no physical collateral needed. Most payday lenders require borrowers to pay a "finance charge" (service fees and interest) to get the loan, the balance of which is due two weeks later, typically on your next payday.
The problem with these loans is that they are extremely expensive, with many lenders routinely charging interest rates of more than 400%. Borrowers often can't pay back these high-cost loans right away, so they get sucked into a cycle of borrowing and racking up finance charges.
Nearly 1 in 4 payday loans are reborrowed nine times or more, research conducted by the Consumer Financial Protection Bureau found. Plus, it takes borrowers roughly five months to pay off the loans and costs them an average of $520 in finance charges, The Pew Charitable Trusts reports. That's on top of the amount of the original loan.
Car title loans, which use the clear title on your vehicle as collateral, are also to be avoided, Borné tells CNBC Make It. These loans have high interest rates — around 300% on average — and are typically only for 15 to 30 days, with the amount borrowed ranging from about $100 to $5,500.
At a time when many Americans may not know when their next paycheck is coming, using a lender who is offering a short-term, one-time payment loan that charges triple-digit APR is a bad idea, Borné says. "Avoid these lenders, they are trouble," she says.
"Lenders who charge extremely high rates don't have a lot of incentive to care whether customers succeed on their loans or not because they make so much money on interest, they can lose the principal and still make money," Borné says.
When shopping around for a loan, really look at the price and how long the lender is giving you to pay back the loan, Borné says. She recommends looking for a loan that charges no more than 36% interest — especially if you have decent credit — and gives you a reasonable period, typically a couple of months to several years, to pay off the balance evenly over the course of the loan.
"Research shows that small-dollar loans can help consumers who are struggling financially, but only if the credit is structured to have affordable installment payments and reasonable time to repay," says Nick Bourke, director of Pew's consumer finance project.
Instead of a single payment loan, consider an installment loan. "Very few consumers can afford to repay loans in a single payment, the way that payday loans have often been structured," Bourke tells CNBC Make It. "Instead, they fare better when they can repay loans in installments over a number of months."
U.S. Bank's Simple Loan is a good example of what responsible loans can look like, Bourke says. The program offers borrowers up to $1,000 for a three-month period and typically charges customers $12 for every $100 borrowed if set up using autopay. Amid the COVID-19 pandemic, U.S. Bank cut its fees in half, now only charging $6 per $100 borrowed. That's about a 24% APR for a $500 loan. U.S. Bank also reduced APRs on its personal loans to 2.99% on amounts between $1,000 and $5,000.
If you want a lower interest rate, try checking out a federal credit union. For most types of loans, the interest rate is capped at 18% at credit unions, while the average rate for a three-year loan is 9.37%, according to the National Credit Union Administration. Indianapolis-based FORUM Credit Union, for example, offers members with fair credit access to a $500 loan with a 10.24% APR for six months and does not require an initial payment for the first 45 days.
Most credit unions have membership restrictions that require you to live in a specific area or work for a specific employer, but there are quite a few that allow anyone to join, usually by making a donation or joining an affiliated non-profit organization.
In addition to bank or credit union loans, Borné adds that credit cards are an often overlooked version of a small loan. Credit cards charge interest rates of about 17%, making them cheaper than many other small loan options.
If you can pay your balance off by the end of the month, a credit card essentially offers an interest-free loan for 20 to 30 days, depending on your specific card. While not everyone has access to a credit card, banks have done a good job of increasing the availability in recent years.
That said, racking up a balance can get expensive quickly. And 38% of American workers end up carrying that balance month to month, according to a survey fielded by Salary Finance of over 2,700 U.S. adults working at companies with over 500 employees. Nearly half of those who have credit card debt owe at least $3,000, which can add up to hundreds per year in interest alone.
No matter who you lend from, take the time to review the loan terms carefully, Borné says. "Predatory lenders exploit people even in the best of times, so we are concerned that they will look to exploit people in this state of extreme vulnerability," Borné says.
"If you can help it, you don't want to be one of the causalities from one of these businesses," she adds.