Payday loans (a.k.a. deferred advance loans, cash advance loans, check advance loans, post-dated check loans, or deferred deposit check loans) are loans borrowers promise to repay from their next paycheck or salary deposit. They are often accompanied by exorbitantly high interest and fees. Borrowers who cannot repay these loans in two weeks are often forced to roll over the loans and can get trapped in a cycle of borrowing over and over and over.
For example: A person borrows $100 until the next payday. The lender provides a two-week loan and charges a $15 fee. The lender will require the borrower to provide a postdated check for $115 to be held until the borrower's next payday. When the loan comes due, the borrower may repay the loan by allowing the lender to process the check or by bringing in the full payment of $115 in cash. The borrower may also have the option to “roll over” the loan by taking out another loan and paying an additional $15 for another two weeks. In this example, the annual percentage rate (APR) calculates to 391% for the original two-week loan of $100 with a $15 fee.
Generally, federal credit unions are limited to a maximum lending rate of 18%, a loan in this way is impermissible. Generally, credit unions offer a much less costly alternative to their members, granting them a loan with no fee; interest is calculated over the term of the loan according to the APR disclosed. Although obtaining a payday loan from a credit union is less costly to the borrower, the credit union assumes a variety of risks.
Note: The Federal Credit Union Act and the NCUA Rules and Regulations set the maximum interest rate federal credit unions can charge on loans and lines of credit at 15% per annum inclusive of all finance charges. The Act permits NCUA to increase the interest rate above 15% for periods of up to eighteen months. The current maximum interest rate is set at 18%. In determining whether a particular charge constitutes a finance charge for purposes of compliance with the interest rate ceiling, we generally follow the Regulation Z interpretation of that term. If the credit union charges a fee only to those borrowers who receive the loan, the fee is included as a finance charge and must be included in the APR calculation.
As of September 2012, the NCUA Board extended the current 18% interest-rate ceiling on loans originated by federal credit unions for an additional 18 months, through March 10, 2014.
This means the maximum allowable Annual Percentage Rate (APR) remains 18% for most loans and 28% for loans made under NCUA's Short-Term Small Loan program.
NCUA Short Term Small (STS) Loan Program
Providing consumers with an alternative to borrowing from potentially predatory payday lenders, the NCUA adopted a rule in 2010 – with a strong set of consumer safeguards – to allow federal credit unions to make STS loans and to extend lines of credit to their members.
Under the regulation, federal credit unions are permitted to charge an interest rate for a short-term, small amount loan that is higher than the ceiling permitted under Federal Credit Union Act, provided that it meets certain conditions. The rule imposes limits on the permissible term, amount, and fees associated with such a loan. The new rule also requires federal credit unions to set a cap on the total dollar amount of such loans that they will make, and it requires them to set at least a one-month period in which a would-be borrower must be a member of the credit union.
The ability to make STS loans will help federal credit unions fulfill their mission of promoting thrift and meeting the credit needs of consumers, particularly those of modest means. Permitting a higher interest rate for such loans will allow FCUs to make loans cost-effectively, even as the limitations set by the new rule will ensure that such loans meet their purpose as an alternative to predatory credit products. The rule also includes guidance in the form of “best practices” that federal credit unions should consider incorporating into their short-term, small amount programs.
To charge up to 28% APR, federal credit unions can offer STS Loans under the following conditions:
- Principal Amount: $200-$1,000
- Term: 1-6 Months
- Application Fee: $0-$20 (based on actual costs)
- Eligibility: Member for at least 1 Month
- Amortization: Fully Amortized (no balloon payments)
- Rollovers: Prohibited
- Limits on the number of such loans to one member within a six-month period
Unlike payday lenders, which rarely report their customers' payment of loans to credit bureaus, FCUs will generally be reporting their members' payment histories with STS loans to the credit bureaus. Members who successfully pay off STS loans at FCUs will likely be able to improve their credit scores and qualify for future loans at lower costs.
Note: The NCUA's rule on STS loans does not prohibit an FCU from continuing or participating in a closed end payday loan or other short term loan program that currently operates successfully and is legal under NCUA's regulations and the Federal Reserve Board's Regulation Z.
For more information about the STS Loan program and the update extending the debt ceiling, refer to both the October 2010 NCUA Regulatory Alert, 10-RA-13, Final Rule - Part 701, Short-Term, Small Amount Loans, and the August 2012 NCUA Letter to Federal Credit Unions, 12-FCU-04, Permissible Interest Rate Ceiling.
To learn more about your loan options, contact your credit union or find a credit union in your area.