Preventing financial catastrophes

Sharon Strahan was living paycheck to paycheck when her car needed an emergency repair. The divorced mother of two tried to get a loan from three banks, but they turned her down.

She believed a payday loan was her only option.

“I thought the payday loan was a source of survival, but the interest rate was eating me up,” Strahan says.

It’s a familiar story. Approximately 130 million Americans live paycheck to paycheck and don’t have the funds to cover a $400 emergency without taking out a loan, borrowing from friends or family, or using a credit card, according to the Federal Reserve.

Strahan visited a Hope Federal Credit Union branch near her home after she heard a radio advertisement about credit counseling. She was surprised when the credit union offered to replace her high-interest debt with a low-interest credit-building loan.

The Jackson, Miss.-based credit union launched “Borrow and Save” in 2014 to expand and update an existing small-dollar loan program. The program aims to help members build up both their credit score and savings account balance. If a member takes out a Borrow and Save loan for $1,000, Hope Federal issues $500 to them immediately, and then puts the other $500 in a locked savings account. Once the member pays off the full balance of the loan, the hold on the savings account is lifted.

Early adopter

Hope Federal is an early pioneer in offering small-dollar loans to help members avoid high-interest payday and auto title loans.

These programs almost always offer credit counseling and an opportunity to build up credit. Credit unions often offer these loans to people who would not qualify for loans elsewhere.

Consumers often turn to payday loans out of convenience. Branch managers at the $301 million asset credit union approve Borrow and Save loans, which expedites the process, says Felicia Lyles, Hope Federal senior vice president of retail operations.  

Hope Federal also considers nontraditional forms of payment histories when making credit decisions, such as a 12-month history of utility or rent payments. The credit union takes on the added risk of these loans because they see a huge need in the community, Lyles says, and so far, the benefits outweigh the risks.

From 2014 to 2018, Hope Federal issued 2,744 Borrow and Save loans for $500 or $1,000. Nearly 70% of the borrowers had credit scores of 599 or less, which makes them ineligible for loans at financial institutions other than payday lenders.

Hope Federal has charged off 24% of these loans. But Lyles says 40% of members who took out the loans were repeat borrowers who paid off the initial loan and qualified for new loans of the same or higher amount.

Next: Adding employees to the mix.

Membership opportunities

Ray Lancaster, CEO of $167 million asset Pyramid Federal Credit Union in Tucson, Ariz., saw how members and employees could be caught in vicious debt cycles from using payday lenders, so he created two programs to meet their short-term financial needs. For employees, he extended a 0% interest line of credit for up to $1,500, which they could tap into at any time.

For members, he partnered with a community institution to pilot a low-interest loan program to consolidate high-interest payday loans. It also offers financial education.

While the program still has some kinks to work out, it has been an effective tool for outreach for the credit union, Lancaster says.

“Many people in our country are one emergency or event away from financial catastrophe,” he says. “Most of the people we’ve helped were not members of the credit union, so it’s opened up new membership opportunities.”

As part of its mission to serve low-income communities as a community development financial institution (CDFI), Peninsula Community Credit Union in Shelton, Wash., launched a Borrow and Save emergency loan program in 2017.

The $190 million asset credit union offers loans of $300, $500, and $1,500 with terms of 3, 6, and 18 months. During the repayment period, borrowers pay an extra 25% above the 18% interest rate, which is deposited into a savings account for them to access once they repay the loan.

‘Many people in our country are one emergency or event away from financial catastrophe.’

Ray Lancaster

One stipulation of the program is that borrowers prepare a budget showing how they will repay the loan. If they complete the budget fast enough, they can get the money within 72 hours of applying, says President/CEO Jim Morrell.

The program is having a positive impact in the community by helping members get emergency money fast, Morrell says. But the saving component of the program hasn’t been as effective as he’d hoped.

“We don’t always see that savings account stick around for all that long,” Morrell says. “The members we’re working with have a lot of financial needs. That money tends to be used for the next best purpose rather than for the next big emergency.”

Next: What solutions does fintech provide?

Fintech solutions

Some credit unions look to fintechs to offer short-term, small-dollar loans. SkyPoint Federal Credit Union in Germantown, Md., launched Flex Loan, a small-dollar loan product powered by QCash Financial’s digital lending platform, in June.

QCash integrates with a credit union’s mobile app and uses machine learning algorithms to automate underwriting. QCash doesn’t rely on credit reports but instead predicts an applicant’s ability to repay based on their history with the credit union. It lets credit unions customize how restrictive they want to be.

Qcash provides lower loan origination costs and loan funding within two minutes of approval, which can make a huge difference for someone short on money.

“We believe we can prove that the data you have about your members is much more current than a credit score is, and it’s much more predictable,” says Ben Morales, CEO of Qcash, a credit union service organization formed by WSECU in Olympia, Wash.

Working with QCash allowed SkyPoint Federal to improve an existing small-dollar loan program by raising borrowing limits from $750 to $1,000 and integrating it with its mobile app so funds can be delivered within seconds, says Sue Hoefs, director of lending for the $150 million asset credit union.

The loans have a 28% interest rate, which is modeled after the NCUA Payday Alternative Loan program. That’s much more affordable than the 300% interest rates payday lenders charge, Hoefs says.

“Members really like it,” says Hoefs. “They’re amazed at how fast the application process is and that the money is in their account within two minutes. This is something that can help our members that other [financial institutions] don’t offer."

Regulators weigh in

Federal regulators, including NCUA, have been exploring ways to encourage borrowers to seek loans at traditional financial institutions rather than payday lenders.

The NCUA Board adopted a Payday Alternative Loan II rule during its September meeting, allowing federal credit unions to make short-term loans of up to $2,000 as an additional alternative to payday loans. The rule expands federal credit unions' options for members and doesn’t impact the current PAL program.

CUNA was supportive of this move because a number of American consumers encounter unexpected expenses and credit unions offer safer and more affordable short-term loans to their members than any other financial institutions. In addition to the recent action by the NCUA Board, CUNA is encouraged by the NCUA Board’s comments that it may consider a third short-term, small dollar loan option that could expand on and provide additional flexibility beyond that offered by PAL II.

Credit unions can customize the details of the loan program they offer with QCash, such as  interest rate, risk tolerance, and level of profitability.

“Short-term credit is about providing instant liquidity to help members bridge the gap when there’s more month than money left,” Morales says. “The need is critical.”