With more than 12 million Americans using payday loans annually, many are beginning to wonder if the government will ever eliminate payday loans. In recent years, the amount of people using payday loans has steadily increased, and so has their debt.
According to a recent PEW’s survey, “5.5 percent of adults nationwide have used a payday loan in the past five years, with three-quarters of borrowers using storefront lenders and almost one-quarter borrowing online.”
“State regulatory data show that borrowers take out eight payday loans a year, spending about $520 on interest with an average loan size of $375.” The PEW Charitable Trust
The Problem with Payday Loans
While having the option to borrow a minimal amount of cash in between paychecks may sound like a great option, the truth is that there are many pitfalls in this gray, state regulated market. Payday loans are more often than not referred to as ‘debt traps,’ and with good reason.
What are often advertised as “small, short-term unsecured loans,’ typically have an annual percentage rate (APR) of nearly 400%! Just to bring this into perspective, your average credit card APRs range between 12% and 30%. With this in mind, it is easy to see how something as simple as a small, short term loan can literally ruin someone financially, and this is exactly what is happening.
“These are predatory loan products. They rely on the inability of people to pay them off to generate fees and profits for the providers.” Greg Mills, the Urban Institute
In 2013, approximately 2.5 million households took out payday loans, which means that payday loans have increased 19% since 2011. (Urban Institute) According to an analysis of payday lending performed by the Consumer Financial Protection Bureau (CFPB), an average 2-week loan of $392 resulted in fees that are the equivalent of a 339% APR. In addition, 80% of the loans were renewed or rolled over, which also resulted in additional fees.
“They [Payday Lenders] end up trapping people in longer-term debt.” Gary Kalman, VP at the Center for Responsible Lending
The Regulation of Payday Lenders
The regulation of payday loans, cash advances and payday advances is something of a gray area, with regulations being made at the state level. Currently, 14 states and the District of Columbia forbid short term storefront lending, while the practice is legal in 27 states. In addition, 9 states allow some form of payday lending services with restrictions. With the widespread use of online lending services, the legalities have continued to pile up.
At the federal level, the Consumer Financial Protection Bureau (CFPB) was given specific authority to regulate payday lending companies, without regards to their size, in the Dodd-Frank Wall Street Reform and Consumer Protection Act.
The Military Lending Act offers some protection for active duty armed forces members with a 36% rate cap on certain payday loans, tax refund loans and auto title loans. In addition, this Act also prohibits certain terms in short-term loans that could be pitfalls for those who cannot afford to repay their debt.
Payday lending companies have even cashed in on Native American reservations ‘sovereign status’ by creating partnerships with tribe members or simply setting up their business operations on tribal land in order to evade state laws and offer their lending services online. However, the Federal Trade Commission (FTA) has also joined the CFPB in monitoring the lenders that fall into this category quite aggressively.
What is the Government Doing about Payday Lending?
While there has been no mention of banning the practice of short-term payday lending, the government and the CFPB are seeking to set new standards for this state regulated multi-billion dollar industry.
“The idea is pretty common sense: If you lend out money, you should first make sure that the borrower can afford to pay it back. But if you’re making that profit by trapping hard-working Americans in a vicious cycle of debt, then you need to find a new way of doing business.” President Barack Obama
In March of 2015, the CFPB announced that they were considering proposals that would end what has now become known as ‘payday debt traps,’ and would cover vehicle title loans, payday loans and certain high-cost installment and open-end loans.
“Today we are taking an important step toward ending the debt traps that plague millions of consumers across the country. Too many short-term and longer-term loans are made based on a lender’s ability to collect and not on a borrower’s ability to repay. The proposals we are considering would require lenders to take steps to make sure consumers can pay back their loans. These common sense protections are aimed at ensuring that consumers have access to credit that helps, not harms them.” Richard Cordray, CFPB Director
In particular, the proposals being considered include 2 ways that lenders would be allowed to continue providing short-term loans that would not cause the borrowers to become trapped in a vicious cycle of debt. Essentially, lenders would have the choice of either preventing debt traps before loaning money or setting standards that would protect consumers against debt traps after the money has been lent.
Proposed Requirements for Debt Trap Prevention
Debt trap prevention measures that have been proposed are intended to prevent a borrower from falling into a cycle of debt caused by taking out a loan that they don’t have the financial capabilities to repay. Essentially, it requires that lenders determine that the consumer is capable of repaying the loan (which would include the principle, interest and additional fees).
Lenders would be required to verify the customer’s borrowing history, major financial obligations and income. In addition, there would be a 60-day ‘cooling off’ period for lenders to adhere to between loans. If a lender wanted to make a 2nd or 3rd loan to the same individual within the 60-day cooling period, then they would have to show documentation establishing that the customer’s financial capabilities have improved, and that they can afford to repay another loan without continued re-borrowing. However, after 3 loans in a row have been provided, all lenders would be forbidden from making a new short-term loan for a full 60 days.
Proposed Requirements for Debt Trap Protection
As a second step for eliminating the debt trap of short-term lending would require that money lenders provide affordable repayment options, in addition to limiting the number of loans that a consumer take out in a row and over the course of a year.
Debt trap protection requirements would prevent lenders from keeping consumers in debt with short term loans for more than 90-days within a 12-month period. In addition, there would be a cap on rollovers that would stop at 2 or 3 loans total, followed by a mandatory cooling off period of 60-days. When making 2nd or 3rd consecutive loans, they would only be permitted as long as an affordable way out of debt is offered by the lender.
There are 2 options for this:
- Either – Require that with each loan the principle decrease, so that after the 3rd loan it is repaid.
- Or – Require that a no-cost ‘off-ramp’ is provided by the lender after the 3rd loan, which would allow the borrower to pay off the loan, over time, without additional fees.
There would also be additional stipulations that under the proposed requirements the debt would not be able to exceed more than $500, require the borrower’s vehicle as collateral, or carry more than 1 finance charge.
While banning the practice of payday lending is nowhere in sight, it’s obvious that decision makers have definitely noticed the pitfalls of current payday lending practices. In an effort to end the vicious cycle of short term lending debt, we are likely to continue seeing new requirements and regulations that are aimed at protecting the consumer from these money-lending sharks.