Walk into a payday lender and you’ll be offered a loan that likely charges between 15 percent and 17 percent every two weeks.
Walk into the RedDough office in Pagedale and you can try for a loan that will charge just 10 percent over six months. For stressed, low-income borrowers — the kind of customers banks don’t seem to want — RedDough is a much cheaper alternative to payday loan shops.
RedDough is a creation of Prosperity Connection, a nonprofit financial education and loan operation. St. Louis Community Credit Union founded Prosperity Connection and works closely with it.
The credit union and Prosperity Connection are performing an experiment. They want to see if a lender can serve cash-strapped, low-income clients without charging sky-high interest rates of the sort once associated with characters who break legs for a living.
It’s a good time to be experimenting. The federal Consumer Financial Protection Bureau has proposed new rules that would restrict payday lenders and limit their clientele. The payday loan industry is howling about it.
Consumer groups bash the payday business for trapping people in ever-escalating debt. Because most borrowers can’t repay after two weeks, the debt gets renewed for another charge. And that can go on and on as borrowers roll over their loans, or take out new ones to pay off old ones.
Payday operators have defended their practices, saying they are the last hope for their customers when an emergency pops up. If your car breaks down and you need to get to work, a payday loan can save your job.
So the question becomes: Can anybody serve this market without creating debt traps?
Prosperity Connection, a charity funded by donors, is giving it a shot at its RedDough Money Center on Page Avenue.
It offers loans up to $500 with six months to repay. Prosperity Connection doesn’t look at a credit report on applicants. Instead, the group collects two pay stubs, and a lender talks to customers to determine if they can repay the loan.
Garylinn Driver, a preschool teacher, has borrowed from the payday shops. “I’m not bashing them,” she says. They were there when she needed them.
But when she needed a recent loan, to help pay for a funeral, she learned of RedDough. “Their rates are bearable compared to some other places I dealt with,” she said.
They also offered her consumer education classes on budgeting, borrowing and improving credit. “I’m doing a lot of things different now,” she said.
Driver got her loan, but 50 percent to 60 percent of applicants are denied because of inability to repay.
“We do not want to put any consumer in the situation that a payday lender does,” said Paul Woodruff, Prosperity’s CEO.
That rejection rate is much higher than at the payday shops, where all that’s needed is a pay stub and a checking account.
The new federal rules would change that. Payday lenders would have to verify the borrower’s ability to repay the loan in two weeks — or accept restrictions on the loan. Under those restrictions, loans could only be rolled over twice, and the amount owed would have to be reduced by a third each time.
The first option would reduce the number of eligible customers. The second would drain the profit in lending, since lenders make the most money by repeatedly rolling over the loans.
In anticipation of the rule, payday operations have been moving more toward multimonth installment loans, usually secured by a car title at interest rates from 200 percent to 400 percent annualized. The proposed federal rules would place restrictions on those, too.
Lenders would have to verify ability to repay on time, or they could require payments no bigger than 5 percent of a borrower’s monthly income.
RedDough, which began lending six months ago, has made 185 loans totaling $68,000. “We have not had any charge-off,” Woodruff said.
He expects to go easy on people who can’t pay. “We’re not going to harass people or garnish their wages,” he said.
Payday lenders commonly seek court judgments and garnish wages for people who default. Around St. Louis, their lawyers get court orders jailing clients who don’t show up for court hearings, and their bail money is often turned over to payday shops to pay down the loans.
St. Louis Community Credit Union has had a payday loan alternative for years. A $500 loan kept for one month would cost $15 in interest. It would cost at least $150 at a payday shop.
The loan includes a mandatory savings account designed to head off the need for more loans in the future. The customer actually borrows 10 percent more than the amount of money the bank hands them. That extra 10 percent goes into a savings account in the customer’s name.
When the borrower repays the loan, that savings account remains. The idea is that a repeat borrower will build up savings. Eventually, the savings account gets big enough to cover the next emergency.
“They walk in and we tell them that they don’t need a loan. They have the money in the savings account,” said Patrick Adams, CEO of St. Louis Community Credit Union.
Borrowers must have had an account at the institution for six months, usually a checking account. That lets the lender see how the borrower handles money. The credit union doesn’t check the borrower’s credit report.
The credit union has 4,000 such loans outstanding, with a $2 million balance.
The credit union makes a “very narrow” profit on such loans, said Adams, partly because of a default rate in the 17 percent range.
“It’s a loan that’s high-risk,” Adams said. “There’s a lot of front-end costs and back-end collection activity.”
That narrow profit may explain why the idea hasn’t caught on among banking competitors. Meanwhile, payday loan shops seem to inhabit every strip mall in blue-collar neighborhoods.
More RedDough offices
Prosperity is planning to open a new RedDough office in south city’s Benton Park neighborhood as part of a new branch being built for St. Louis Community Credit Union.
The credit union is designated a “community development financial institution.” The title goes to credit unions that serve poor areas and makes them eligible for federal aid. Adams says all but one of his 14 offices are in “stressed” neighborhoods.
Federal aid is helping build the Benton Park branch as well as rebuild a branch at the former site of Gateway National Bank in north St. Louis.
That aid comes in the form of federal tax credits. U.S. Bank is buying those credits for $1.3 million, and also donating $15,000 to Prosperity Connection.
The new payday rules are out for public comment. They are expected to take effect next year.