Direct-deposit loans, which are offered by banks including U.S. Bank, Wells Fargo and Regions Financial, enable bank depositors to borrow money against their next paycheck, Social Security check or unemployment benefit that is directly deposited in their account.
Banks that offer these types of loans say their products are different from payday loans because they have lower interest rates than traditional payday loans, and loans are made only to existing customers. In most cases, customers can only borrow up to a maximum of $500, but some banks, including Wells Fargo, limit the loan to half of the direct deposit or $500.
The idea behind direct-deposit loans is to give customers access to emergency cash for which the bank is automatically reimbursed a few days to a couple of weeks later, depending on when funds are deposited in their bank account.
A center study says the loans can have an annual interest rate of 365 percent based on the typical term of 10 days.
Unlike a payday loan in which the consumer typically has 14 days to pay it back, with direct-deposit loans consumers may not even have the money for a full 14 days before it's repaid, says Lauren K. Saunders, managing attorney at the National Consumer Law Center, the Washington, D.C., nonprofit advocacy group.
"Depending on how long the loan is outstanding, the interest rate can be 300 percent to 400 percent," Saunders says. As soon as a direct deposit comes into the account, "which could be three days later," the bank takes the money plus interest, she says.
Direct-deposit loans aren't cheap
In June, the Office of the Comptroller of the Currency, which regulates banks, proposed guidelines for direct-deposit loans, warning banks not to automatically enroll consumers and urging banks to limit repeat loans and to clearly disclose fees.
Jean Ann Fox, director of financial services for Washington, D.C.-based Consumer Federation of America, the consumer advocacy group, says banks provide "voluminous disclosures" on these types of loans. But the information only refers to a loan held for a full year, not as if it was paid back in a few days.
Wells Fargo charges $1.50 for every $20 borrowed up to $500, while U.S. Bank charges consumers $2 for every $20 taken out up to $500. Regions Financial charges $1 for every $10 borrowed up to $500.
Richele Messick, a spokeswoman for Wells Fargo, says direct-deposit loans are available to consumers that have established relationships with the bank and have a recurring direct deposit into a checking account. While Messick says the bank makes it clear this is an expensive form of credit, she says there is a need for this product because it's designed to help customers through an emergency situation. "It's not intended to solve longer-term financial needs," Merrick says.
Regions Financial spokeswoman Evelyn Mitchell says its product is intended to help customers with occasional and immediate credit needs. "We have a number of safeguards in place to reduce the likelihood that someone might become dependent on it. We report repayment history to the credit bureaus, which helps customers establish or rebuild their credit," Mitchell says.
For instance, Regions has a one-month cooling-off period after six consecutive months of maximum credit line use. Customer can't access direct-deposit advance loans if they have other lines of credit or a credit card through Regions.
According to Regions, more than half if its customers who utilize the direct-deposit loans have annual incomes of more than $50,000.
Teri Charest, a spokeswoman for U.S. Bank, says for customers to access the bank's Checking Account Advance, they have to be a customer for six months and have recurring deposits for at least two months. Charest says the product is designed for "unexpected, short-term borrowing needs." U.S. Bank has limitations as to how long the product can be used and tries to redirect customers to other credit alternatives or credit counseling when needed.
Cycle of debt
The downside of direct-deposit advances doesn't stop at the stiff fees associated with them. These types of loans can create a cycle of indebtedness because the bank gets paid automatically once money comes into the account, according to the National Consumer Law Center.
"If you have expenses the next day, you risk bouncing a check or triggering overdraft fees on top of the loan," says Saunders.
A study by the Center for Responsible Lending found borrowers of this type of loan are in debt for 175 days of the year -- or nearly six months -- even though it's designed to be a short-term loan product. What's more, nearly one-fourth of all borrowers are Social Security recipients. According to the Center for Responsible Lending, banks will loan up to half of a customer's monthly direct deposit.
"It leaves them with only 60 percent of their income to meet other basic necessities," says Standaert. As a result, consumers keep taking out loan after loan, she says.
Alternatives to direct-deposit loans
Consumers, even those who are struggling, have alternatives to direct-deposit loans. Fox says the first defense is to have an emergency savings account. If that isn't an option, accessing cash from an overdraft line-of-credit tends to have an interest rate of 18 percent, which is much lower than a direct-deposit advance.
While credit cards charge high interest rates for cash advances, Saunders says they're better than the interest charge on direct-deposit advance loans.
"Credit cards have a rate under 36 percent, and the minimum payments are smaller. It's a much better alternative," says Saunders, noting that consumers should avoid direct-deposit loans. "Even if you think you are desperate and need it right now, you'll just be in a worse position next month."