By Cyril Tuohy
The free market is a contradictory animal indeed.
On the one hand, institutions and high-net-worth investors with billions of dollars of assets fight tooth and nail to pay lower fees.
At the other end of the spectrum, tens of millions of consumers – the unbanked or the underbanked – who often can’t even pay their monthly bills pay billions of dollars annually in fees and outrageous interest.
Critics and consumer protection advocates have called such payday lenders usurious, robbing consumers of millions of dollars every year.
In response, alternative financing lenders respond that they are not doing anything illegal, but simply filling a need at whatever rate the market will bear.
Either way, the numbers of consumers who are on the fringes of the banking system or who don’t participate in it at all are staggering.
The Federal Deposit Insurance Corp. (FDIC) estimates that one-third of the U.S. population does not maintain a bank account. This segment of the population typically chooses to access funds through alternative financial networks.
Most of the time, these consumers pay through the nose for the privilege and often don’t realize it.
“For an average storefront loan, the amount due on payday is $430, said Nick Bourke, director of the Safe Small-Dollar Loans Research Project with The Pew Charitable Trusts. “For someone who makes $31,000 per year, the median payday borrower’s income nationwide, $430 represents 36 percent of his or her biweekly income, before taxes.”
Bourke was among the witnesses who testified before the Senate Committee on Banking, Housing & Urban Affairs about whether alternative financing products were serving consumers.
You can’t blame financial advisors for ignoring the unbanked segment. After all, these consumers are not even part of the financial system, let alone being candidates for life insurance, retirement products or investment advice.
But think about it.
Consumers taking out loans at the equivalent of as much as 1,000 percent interest per year on a $400 loan to pay for daily living expenses are paying more in interest “fees” than any middle-market or high-net-worth consumer would dream of paying in a lifetime.
And these consumers don’t think twice about borrowing from all sorts of dubious sources: storefront payday loans, title loans, storefront installment loans, even online lending organizations. As a result, some of the nation’s poorest consumers with few assets routinely pay the highest fees.
Meanwhile, in the corridors of Congress, the gilded offices of the Securities and Exchange Commission (SEC) and shiny K Street offices, lawmakers, lobbyists and policy experts battle over advisors’ fiduciary duty to investors, and draw up rules about what advisors can and cannot do with regard to advertising and marketing to billion-dollar institutions.
One common form of payday lending allows consumers to borrow at a rate of $15 and $25 per $100 for a period of 14 days or less, but payday lenders have every incentive to make sure borrowers repay the loan over a longer term.
“Typical state payday loan laws (in states that have them) limit interest and fees to $15 per $100 (390 percent or more) but only if the loan is 14-35 days in duration. These laws do not apply to longer loans,” said Nathalie Martin, a professor and alternative financing product expert at the University of New Mexico School of Law.
Despite bipartisan support for interest rate caps, and agreement from conservatives and liberals, no federal law regulates rate caps on consumer loans, and only one-third of the states regulate high-cost credit.
As a result, there’s no limit to the number of alternative financing products the market will come up with to fill the needs of the unbanked.
Even rate caps have been a failure, Martin said. Lenders simply develop new loan terms to get around the regulation.
Bourke said more of the nation’s unbanked are turning to prepaid cards, and the very reason for doing so is to avoid bank overdraft fees, debt, spending and to steer clear of temptations of credit — in other words they want to control their spending.
Controlling debt, limiting spending — isn’t that why many people seek the help of an advisor in the first place?
Even if the unbanked don’t have much to offer advisors in terms of assets, they could certainly use help some in budgeting, spending and borrowing. From the looks of it, these consumers are certainly willing to pay for it.
Cyril Tuohy is a writer based in Pennsylvania. He has covered the financial services industry for more than 15 years. Cyril may be reached at [email protected].
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