Our Neighborhood Banks:
High Cost Loans for Low Income Borrowers

This article was written by the Consumers Union Southwest Regional Office.

Executive Summary

Pawn shops and finance companies locate in low income and minority communities, and charge very high interest rates and fees for their services. While low income consumers represent a somewhat higher risk to lenders, the corporations return solid and sometimes spectacular profits to their investors and parent companies-in some cases major banking institutions who in their mainstream operations generally shy away from the inner cities and higher risk loan markets.

Consumers Union created maps of the locations of pawn shops, finance companies and branch banks in Houston, Dallas and Austin. The maps confirm several previous findings about the demographic characteristics of those who borrow from fringe lenders. They suggest that in addition to serving predominantly young, non-white, and low to middle income clients, they physically locate near populations with many of these characteristics. A majority of the fringe lenders in three Texas cities we examined are located in and around predominantly minority neighborhoods and neighborhoods with below median household income.

Pawn and finance company loans are quick and convenient, but costly-borrowers may pay many times the interest rates charged by mainstream banks. Borrowers at pawn shops pay a monthly fee of 20 percent of the loan each month for loans under $132, or 240 annual percentage rate (APR) to keep pawned items from becoming the pawnshop's property. For personal loans, finance companies typically charge the highest interest rates allowed under the Texas Credit Code-equivalent to an of more than 30 percent or 90 percent APR, depending on the size of the loan.

While few major banks serve low income neighborhoods, some benefit directly from the profits their own subsidiary finance companies make serving these same areas. For example, NationsBank profits from the good returns of NationsCredit. Norwest attributes a disproportionate share of profits to its own finance company subsidiary.

Competition among finance companies has not lowered the cost of loans. Instead, consumers with limited financial resources, consumers who live in low income or minority neighborhoods, and those with glitches in their credit history can get loans, but pay much more in interest, fees and other charges than their credit risk warrants.

In order for lower income consumers to have equal access to fairly priced financial services, Consumers Union recommends:

• fair maximum interest rates;
  
• terms and conditions borrowers can reasonably be expected to fulfill;
  
• prohibition of credit related products (like non-filing insurance) that are over-priced, not subject to market forces, or not in the interest of most borrowers;
  
• disclosure and potential penalties if a refinancing results in higher overall cost to the borrower;
  
• a fair refund of unearned interest using the actuarial method rather than the Rule of 78s;
• no new administrative fee added on to refinancings;
  
• adequate court remedies (consumers can pursue lenders under DTPA for abusive lending practices);
  
• subsequent purchasers of loans will be subject to all claims and defenses based on the conduct of the original lender;
  
• mechanisms to ensure pawned goods are returned in the same condition in which they were left;
  
• an independent Office of Access to Financial Services directed to study and recommend changes to improve the personal loan market;
  
• programs to improve equity in the financial services market:
  • Banks that own finance companies should have programs to effectively graduate finance company borrowers to lower cost bank loans.
  • Banks marketing loans by mail should market in low income areas.
  • Banks should examine their underwriting policies to ensure that they are not unfairly excluding these customers.
  • Require banks to offer lifeline checking to ensure that low income consumers can afford to develop a relationship with mainstream banks.