To millions of member-customers, credit unions are the financial equivalent of a trusted uncle, dispensing prudent loans for cars, homes, and education without the profit motive of traditional banks.
But encouraged by federal regulators, an increasing number of credit unions are competing directly with traditional payday lenders, selling small, short-term loans at prices far higher than they are permitted to charge for any other product.
In September, the National Credit Union Administration raised the annual interest rate cap to 28 percent from 18 percent for credit unions that offer payday loans that follow certain guidelines. Under this voluntary program, credit unions must allow at least one month to repay, and cannot make more than three of these loans to a single borrower in a six-month period.
But because these firms can charge a $20 application fee for each new loan, the cost to borrow $200 for two months translates into an annual rate of more than 100 percent.
“We spent a long time trying to do this in a way that would work for members and for the credit unions and not be predatory,” said NCUA Chairman Debbie Matz.
What’s more, many credit unions prefer to sell loans outside the federal program, allowing them to charge customers significantly more to borrow.
At Mountain America Federal Credit Union in Utah, a five-day $100 “MyInstaCash” loan costs $12, which works out to an 876 percent annual interest rate. An iWatch News investigation found 15 credit unions that, like Mountain America, offer high-cost loans that closely resemble traditional payday loans.
“They are promoting these loans as payday alternatives, but they are not really alternatives; they are egregious payday products,” said Linda Hilton, a community activist in Salt Lake City. “We look at it as a moral lapse of credit unions.”
All told, more than 500 federally insured credit unions are making payday loans in an industry struggling to remake itself after the financial crisis of 2008-2009. Rates for the short-term loans vary widely from the high-triple-digit-rate loans sold by Mountain America to a modest 12 percent interest rate with no fees at State Employees Credit Union in North Carolina.
Consumer groups typically warn against borrowing at interest rates higher than 36 percent per year. That’s the maximum allowed by many states and by the Pentagon for loans to active-duty members of the military.
The push into payday lending comes at a time when some credit unions are facing questions about their financial viability. Credit unions operate as nonprofit groups and can’t raise investor capital as banks can when times are lean. The NCUA has designated about 7 percent of about 4,600 credit unions as either a serious supervisory concern or at high risk of failure.
Thomas Glatt, an industry consultant in North Carolina, said although most credit unions offering payday loans do so to give members a better alternative to storefront payday lenders, some see the loans as a new revenue stream to shore up crumbling finances.
“Not every credit union is as pure as they could be,” he said. “If they are offering something similar to what is sold on the street corner, you have to wonder if that is keeping with the credit union philosophy.”
It isn’t clear how profitable payday lending is for credit unions. But there is potential for big profits. Payday lenders extended an estimated $40 billion in credit in 2009, according to Consumers Union. Profits were about $7 billion.
Many of the credit unions that offer high-cost loans declined to discuss their profitability, but NCUA filings show that Mountain America Financial Services — which administers the Mountain America credit union payday program — reported profits of $2.4 million in 2010. That includes profits from its insurance business, which the subsidiary operates.
Still, several that offer low- or moderate-priced loans said they either broke even or lost a little money on their programs.
For now, most credit unions that offer payday loans do so outside the new federal program. Those that do so must follow the old 18 percent interest rate cap. Some get around the restriction by charging high application fees.
At Kinecta Federal Credit Union, which has branches throughout the country, a $400 two-week loan costs $42.25.
That’s an annualized interest of more than 350 percent, well above the allowable federal limit. But in calculating the charge, Kinecta says that just $3 is interest. The rest comes from a $39.95 application fee, which is charged each time — even for repeat borrowers.
Kinecta Vice President Randy Dotemoto said that it could not afford to make loans for less. He said that credit unions are permitted to exclude application fees from financing costs under the federal truth-in-lending law.
Other credit unions, such as Mountain America, sell loans in exchange for a commission by third-party payday companies with such names as “Quick Cash” and “CU on Payday.”
Mountain America referred questions to Scott Simpson, head of the Utah Credit Union Association, a trade group.
“They are creating an alternative in the marketplace,” Simpson said. “The demand doesn’t stop if these loans go away.”
In other cases, the loans are financed by a state-chartered credit union, such as Mazuma Credit Union in Missouri, which does not have to comply with federal lending rules. Missouri imposes few restrictions on loans made in the state.
Lauren Saunders, a lawyer at the National Consumer Law Center, said regulators should stop these relationships. “They should prohibit any federal credit union from partnering with payday lenders or marketing anything that they would be prevented from offering themselves,” she said.
The NCUA said it does not have the authority to shut down loans funded by third-party lenders. It added that any loan offered by a credit union must comply with the federal truth-in-lending law, but the agency declined to comment on whether specific firms were in compliance.
On a recent Saturday morning, Sam Heredia, 29, a producer for a Spanish-language morning radio show, stopped in at a branch of Nix Check Cashing, a Kinecta subsidiary, in a middle-class neighborhood near downtown Los Angeles.
The biggest drain on his finances is his car, a 2007 Toyota Tundra, Heredia said. Every two weeks for the past year, Heredia has borrowed $400 from Nix. That means he has paid about $1,000 in interest — a 362 percent annual interest rate.
“I think it’s a high percent,” he said.
Douglas Fecher, the president of Wright-Patt Credit Union in Dayton, Ohio said that a fee on top of interest is necessary to make loans affordable.
A $250 “Stretch Pay” loan comes with a $35 annual fee, which goes into a fund that backstops losses at about 50 Midwest credit unions. That fee could push the effective interest on a borrower who takes out two or three loans well above 100 percent per year.
But Fecher said that a lender earns just $3 on a $250, 30-day loan offered at 18 percent interest. “If one person doesn’t pay that back, we would need to make 80 more loans to make up for it,” he said.
His payday loan “doesn’t save the world,” he said. “But it’s cheaper than what they can get somewhere else.”
Freelancer Bethany Firnhaber contributed reporting in this story.
Hallman is a writer for iWatch News.org, a Web site of the Center for Public Integrity, which is a Washington-based nonprofit group focused on investigative journalism.