Case in Point: Testing an affordable alternative to payday loans in Mississippi

February 7

The big idea: Southern Bancorp, a community development financial institution based in Arkadelphia, Ark., serves distressed rural markets that see growing demand for small, unsecured lines of consumer credit. Those markets attract payday lenders, whose same-day loans carry triple-digit interest rates and can trap vulnerable borrowers in a cycle of debt. Southern is testing affordable consumer credit products and ways to educate low- and moderate-income individuals about managing debt and protecting their finances.

The scenario: As banks consolidate and abandon rural markets, many consumers are left with no access to mainstream financial products such as bank accounts and low-cost loans, which makes them vulnerable to predatory lending practices.

Southern Bancorp’s Mississippi market is home to more than 1,100 payday lenders operating out of storefronts in distressed communities. The payday lenders offer short-term, high-interest loans — typically $100 to $400 — that are marketed as a quick, easy way to tide borrowers over until the next paycheck. Those small loans, however, can morph into thousands of dollars of debt. How? The entire balance of a payday loan is due in two weeks. But borrowers already on shaky footing usually lack the funds to meet that deadline and are often forced to renew the loan. According to the Center for Responsible Lending, a North Carolina nonprofit that tracks predatory lending practices, only 1 in 100 payday-loan customers pays the balance by the original due date; on a $325 loan, borrowers end up repaying $793 on average. Mississippi payday lenders typically charge about $21.95 to loan $100 for two weeks, which translates to an annual interest rate of 572 percent.

The resolution: Fifteen states have banned payday loans. Eliminating them, however, is easier than providing viable alternatives. With that in mind, Southern recently began testing a product it calls the Liberty Line. Offered in Sunflower and Coahoma counties in Mississippi, the Liberty Line has a one-time application fee of $25 and an interest rate equal to the sum of prime rate and 5 percentage points (which with current prime of 3.25 is 8.25 percent), and no collateral requirements. Southern has made 99 Liberty Line loans, with an average outstanding balance of nearly $1,000 out of an average available credit line of $1,600. Customers can withdraw funds the same day they apply, with loan amounts up to either 1.5 times their monthly gross income or 20 percent of their net worth, whichever is less. Defaults are practically zero, but there is not enough data to determine the product’s long-term success and scalability.

Southern also offers financial counseling to help people select and manage appropriate and affordable credit products. The process takes longer than applying for a payday loan, but it helps borrowers improve their credit scores, develop better financial habits and achieve long-term financial security.

The lesson: Southern’s Liberty Line and other financial products, combined with credit counseling, serve an important function: They steer consumers in rural markets away from expensive and minimally regulated alternatives such as payday loans, which can undermine the financial security of customers and, ultimately, their communities.

Gosia Glinska

Glinska is a senior researcher at the University of Virginia Darden School of Business.

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