February 25, 2010. The implementation of the Card Act of 2009 and the Overdraft Fee Legislation marks an increasingly shifted focus from traditional loan products to payday loan type services by big banks , observes a Bloomberg article and Solomon Finance.  Although the new reforms have made it difficult to sustain profitability from credit card and overdraft fees, two of banks’ most profitable products, questions arise whether the recent push for short term small cash loans, more commonly called checking advance products, will be successful for national banks while competing with direct payday loan lenders.

Recession Piggy Bank

Checking advance products are cash loans usually ranging from $100 – $500 with annual interest rates at about 120% if paid within 30 days.  These products are not new to big banks: Wells Fargo have had these loans as part of their offerings since 1994 and in 2008 by Fifth Third Bank.  These offerings are similar to payday loans with comparable interest rates and repayment time frames, usually occurring on the borrower’s next pay period with the added convenience of automatic payment withdrawals due to the issuance of the borrower’s account by the corresponding bank.

By getting into the payday loan business, big banks face two major issues: competition from established payday lenders with years and even decades of experience, and the real-life ability to profit from $500 loans with existing big-bank overhead.

Established payday lenders, whether it be online payday lenders or brick-and-mortar paycheck cashing stores, have gotten quick cash loans down to a customer service-oriented science where loans can be approved within seconds and cash can be delivered to the customer within hours; with an online payday loan lender, the entire process  can be done from the customer’s computer at practically any place in the world with an internet connection; in addition, the flexibility and added convenience such as faster customer support via multiple methods such as email, phone, fax, and the ability to customize loan features that stem from the smaller scale nature of payday loan lenders, presents a niche-barrier that may be difficult for national banks to overcome.

Replicating the payday loans business model while searching to fulfill the gap caused by the Overdraft Fee Legislation and Card Act of 2009, will prove to be an obstacle for traditional banks, interesting to follow throughout the rest of 2010.

The new Credit Card Reforms, known as the CARD act, implemented on February 22, 2010, enforces some stringent rules on credit card companies to protect consumers from ambiguous credit terms, fluctuating interest rates, and uninformed decision making. With these changes in effect, banks will focus on lending to those with near-perfect credit, possibly causing consumers with not-so-perfect credit to seek alternative types of loans such as payday loans.

If regular consumers are finding it difficult to make ends meet in between paychecks without the ability to apply for traditional loans, they may have to turn to payday lenders who offer an easier and faster way to obtain quick cash.   This is evident in the increase in earnings by Texas-based cash loan company which had doubled their fourth quarter earnings to $33 million and another advance company who had tripled their earnings to almost $20 million.

The new credit card reforms, effective in early 2010, prohibits credit card companies from sporadically increasing high interest rates to consumers, however, it does not fully prevent other types of fees such as zero balance and inactive card fees.  Because of this, credit card companies will increasingly tighten up lending to customers, especially those with poor credit history,  to reduce lending risks, especially when charging higher interest rates to paying consumers are not an option for recouping losses.    This is why payday loans seem like an attractive alternative.

Payday loans are short term, small cash loans, usually between $100 – $1000, granted to consumers with the loan due date being the next pay date, although some payday lenders allow for due date extension.   The advantage of payday loans, relative to traditional loans, are that they are much easier to qualify for and faster to obtain with some payday lenders offering an online service where one can apply for and be approved for a payday loan online.

Traditional bank loans and credit card criteria usually require a higher credit score and clean credit history in addition to a longer employment history (usually a minimum of two years), and housing history (also a minimum of two years).  With payday cash loans, the usual requirement is employment with income enough to substantiate repayment.

Because of the ease of obtaining payday loans, they are considered high-risk loans which are reflected in larger interest rates ranging from 15% – 30% with APR ranging from 300% – 800%.  Hence, those who get payday loans are advised to pay them off during the first due date as to not incur late payment penalties or loan extension fees.

With payday loans, just as with credit card debt and other types of loans, if consumers are well-informed of the pros and cons of terms, they will be better able to make the right decisions.

With the new implementation of the credit card regulations, known as the CARD act, consumers may have to seek alternative lending such as payday loans.  When we put restrictions on banks, they can’t charge as much, the inability to profit off of high interest rates makes them take less riskier loans which means that customers who don’t have perfect credit may have to turn to alternative types of loans such as payday loans… read more about it here.