The more short-term, small-dollar credit options, the better

The COVID-19 pandemic continues to damage many people’s personal finances and has compelled them to seek relief through any number of options, from home equity loans to skipping mortgage payments and more. As the incoming Biden administration makes plans to put America on a path to sustainable economic recovery, it’s critical that lawmakers carefully consider the long-term unintended consequences of measures that are designed to help. One worrisome example is the notion that we can help the underbanked by taking “unaffordable” alternative credit options away from them, which will do more harm than good and isolate millions of already struggling Americans.

Indeed, the need for consumer credit alternatives is probably greater than many people recognize: 42 percent of people have non-prime credit scores and are ineligible for traditional credit products. Three in 10 adults have inconsistent family income that varies monthly. One in 10 adults struggles to pay bills because of monthly changes in income. Consequently, about 15 million Americans use small-dollar loans each year.

Typically, when consumers borrow small-dollar loans from non-bank institutions, the principal ranges from $50 to $1,000 and is designed to be repaid in full within several weeks to several months. Because these loans have relatively higher interest rates than bank-offered products (which are much larger loans with much longer repayment), some policymakers in D.C. and state legislators in California, Nevada, New Mexico, and elsewhere believe that small-dollar lenders are predatory. Thus, these policymakers seek to limit the products that small-dollar lenders can offer, the fees and interest they can charge, and where and how they can operate. The goal seems noble — protecting consumers from unreasonable indebtedness — yet these opinions don’t reflect the government’s own research on the cost of providing small-dollar credit or the realities of how COVID-19 has damaged the economy in these states.

In an August research paper, the Board of Governors of the Federal Reserve issued findings that the break-even finance charge on a loan of $594 is a staggering 103.54 percent per year — over three times higher than what many consumer groups consider “fair.”

Although it is an expensive form of credit, without these options, many people in desperate circumstances might consider taking on unsurmountable credit card debt. Yet during the COVID-19 pandemic, this option as narrowed, with an estimated 70 million people having had their credit card spending limits slashed or their accounts canceled altogether, without warning, earlier this year.

Banks are stepping in to help close this credit gap. To help customers weather the storm, Bank of America Corp. recently announced plans to offer short-term, small-dollar loans to some of its customers through what it is calling “Balance Assist.” Here’s how it works: Customers with checking accounts over one year old can apply to borrow up to $500 for a flat fee of $5. The bank will require that the loan, available in $100 increments, be repaid in three equal installments within 90 days.

BofA should be applauded for helping customers who need liquidity and who are facing unexpected expenses. Indeed, two-thirds of Americans in a recent survey say they are living paycheck to paycheck, and 82 percent admit they could not cover an unexpected expense of $500.

Thus, BofA obviously is satisfying an important consumer need. US Bank and KeyBank are two other large banks that are providing small-dollar, short-term consumer loans.

These products are good news, and they provide a great addition to the mosaic of choices available. Yet greater options are still needed. Many people do not even have a bank account and therefore would not be eligible for a program like Balance Assist. Notably, 16 percent of African Americans do not have a bank account, and women are more likely than men to be “underbanked” and therefore need alternative, non-bank credit.

Like the short-term loans that BofA is offering, the short-term, small-dollar loans offered by alternative lenders often serve as a vehicle for people with non-prime credit scores to establish or raise their credit scores. This is a benefit that provides longer-term dignity and upward mobility and goes beyond the short-term need to pay the bills.

Small-dollar borrowers understand very clearly the debt and fees they are taking on for a short, foreseeable period. Thus, they should be capable of making their own informed decisions based on their specific needs, without the government limiting their credit options.

Just because some traditional financial institutions like Bank of America are offering small-dollar loans does not mean that other options should be legislated or regulated into oblivion. There are still people who need them — especially in the context of the pandemic. Unless replacements were put in place, eliminating any of the credit options that currently exist for underbanked consumers would exacerbate the economic harm caused by COVID-19.

Kent Kaiser, Ph.D., is secretary/treasurer of the Domestic Policy Caucus.