People who turn to payday lenders need more protection, not less
What may have passed off as a benevolent idea eons ago – lending a few dollars to a cash-strapped consumer until the paycheck arrives – has been repeatedly exposed as a financial giant. Most Americans know that a payday loan is the worst financial instrument on this side of Hades. With their snowballing fees, high interest rates, and auto-renewing if they don’t get paid back on time, why the hell would a financially healthy person get one? Better yet, with their inherently dangerous conception as a financial product, why would a self-respecting consumer protection agency like the Consumer Financial Protection Bureau decide to deregulate them?
Recently, the CFPB announced its intention to roll back the rules finalized in 2017 to help borrowers avoid this debt trap. These regulations, due to come into effect later this year, would require payday and car title lenders to assess a borrower’s repayment capacity before taking out a high-interest loan and limit the number of loans on loan. salary that a person can renew.
Consumers who use payday lenders borrow against their next paycheck. They have jobs, but as you might expect, these households tend to have low incomes and few financial assets. The average user pays more than $ 500 in annual interest on their loans and earns less than $ 40,000, according to a 2012 Pew study on payday loans.
The annual percentage rate for a two week loan ranges between 300% and 400%, with typical fees of $ 20 per $ 100. A loan of $ 300 requires a repayment of $ 360. A missed payment comes with an extension fee of $ 60 or a second loan of $ 360. After one month, the borrower owes $ 420, or up to $ 720.
Studies show that some consumers have taken more than a dozen loans in a year, or borrowed from multiple payday lenders to pay off another. The business model is easy to understand: the lender is betting on the borrower’s inability to repay while still collecting profitable interest and extension fees.
Who uses payday loans is emblematic of a larger problem. For a multitude of reasons, banks do not provide the financial products and services, such as small dollar loans, that low-income consumers need. These are consumers traditionally underserved by the formal banking economy. Those who use payday loans are underbanked: they have bank accounts, but they don’t have access to bank credit or other basic banking options, sometimes because they have low credit risks.
Other consumers choose to “do banking” outside of the formal banking economy because they find minimum account balances too high, bank charges unpredictable, or simply “don’t trust the banks”. These borrowers rely on so-called fringe banks – like payday lenders, check cashing services, and pawn shops – despite the stigma and the extra expense because they have few alternatives. But many Americans don’t have enough savings for unforeseen or urgent needs, as the recent federal government shutdown demonstrated.
Particularly in communities of color, where, according to a recent study, bank fees remain racialized in terms of higher bank fees and credit scarcity, payday lenders continue to thrive. Payday lenders are standing on the sidelines, encouraging borrowers to take out new high interest loans to pay off old loans over and over again.
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To be sure, states are avoiding payday loan reform because of the competing interests of borrowers and lenders. Ohio, which was previously among the nation’s most expensive payday loans, recently passed pricing and affordability legislation that can serve as a boost. The legislation extends the repayment period of a loan up to three months and limits the monthly payments to 6% of the gross monthly income of borrowers. The interest rate is set at 28% and the total fees are limited. More importantly for consumers, payments are split evenly between principal, interest, and fees. The pricing is advantageous for lenders with substantial savings for consumers.
Despite claims that they are too regulated to be successful, payday lenders make about $ 46 billion in loans and collect $ 7 billion in fees per year. This makes the rationale for modifying existing rules counter-intuitive. The CFPB justifies the reversal of the rules because the assessment of a borrower’s repayment capacity imposes “substantial burdens” on the industry. Restricting the number of payday loans a borrower can defer and shortening the repayment period “could create financial hardship” for the borrower. These explanations ring hollow without concomitant changes in the structure of loan fees. The new rules are clearly the antithesis of consumer protection.
Recently, banking regulators have allowed banks and credit unions to offer the types of small loans that most borrowers can afford. The small installment loan has monthly payments that do not exceed 5% of the borrower’s monthly income, with significantly lower fees.
Employers are also offering game-changing practices. Some employers plan to pay workers weekly rather than bi-weekly. Others offer small, short-term loans against employee paychecks. These are beneficial ways of providing access to credit for this market segment.
The proposed rescinding of payday loan regulations only helps one part of the payday lending industry, not borrowers. Underserved borrowers will benefit from greater competition for the types of products and services they need.
Cassandra Jones Havard is Professor of Law at the University of Baltimore School of Law, where she teaches banking regulation, corporate law and commercial law.