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Is a direct-deposit advance a payday loan?

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Federal regulators have announced that they are imposing new regulations on direct-deposit advances, a short-term loan service offered by some major banks. Regulators have compared the advances to payday loans, in that both services don’t vet a borrower’s ability to repay a loan, have a very quick turnaround, charge high interest rates, and are difficult to repay for some borrowers.

Banks argue that their advances are a better alternative to payday loans, but the Consumer Financial Protection Bureau (CFPB) recently released a report arguing that the two are very similar. While a direct-deposit advance is not technically a payday loan, it follows a similar model and poses the same risks and benefits to borrowers.

What is a direct-deposit advance?

A direct-deposit advance is a service offered by some major banks. Members with qualifying bank accounts can receive a line of credit usually up to $500, with an average charge of $10 for every $100 borrowed.

The loan is repaid when a direct deposit of a certain amount, $100 or more at some banks, is deposited into a borrower’s account. If the deposit does not cover the full amount of the advance, the bank will pay itself regardless. This leads to additional interest charges and overdraft fees for the borrower.

A report by the CFPB found that both payday loans and direct-deposit advances meet the same criteria for high-risk loans. First, both are short-term loans. The average payday loan period is two weeks, and the average direct-deposit advance loan period is 12 days. Both have average APRs above 300 percent. And while both are meant to be short-term quick fixes, borrowers tend to become repeat users and remain indebted to their lender for months, not weeks.

Is a direct-deposit advance as expensive as a payday loan?

If borrowers are choosing between the two, they might still be slightly better off with a direct-deposit advance. Though both loans have high APRs, direct-deposit advances tend to be slightly less expensive. However, because direct-deposit advances require borrowers to have an account with the bank, payday loans are more readily available.

The key thing to remember is that borrowers fall into trouble with payday loans and other types of cash advances when they can’t pay them back. If borrowers don’t overestimate their ability to repay a short-term loan they will be able to avoid the cycles of debt consumer advocate groups warn against.