Payday loans serve as a last resort for people with poor borrowing histories and little savings, carrying punishing interest rates of 300% or more on an annual basis – an order of magnitude more expensive than the most expensive credit card. And unsurprisingly, more than three-quarters of borrowers fail to repay their payday loans when due (usually within 30 days), leading to steep penalties that force many borrowers into loan after loan to as their debt increases. That’s why 14 states have deemed this form of non-bank lending inherently abusive and have effectively banned it.
Nevertheless, payday loan points are ubiquitous in states where they remain legal; by one count, they outnumber the McDonald’s franchises there. About 12 million people take out payday loans every year, with an estimated $24 billion borrowed in 2015. Alarmingly, most of this volume is made up of repeat loans to people who borrow multiple times in quick succession. The industry may label payday loans short-term financing for people with unexpected bills to pay, but data suggests they’ve become an expensive crutch for those who don’t earn enough to make ends meet.
Policymakers have known for years about the threat payday loans pose to desperate borrowers, but federal banking regulators have done nothing because payday lenders are beyond their jurisdiction. This left it to the states to set the rules, resulting in a slew of insane requirements and limits that lenders could easily circumvent through online or overseas operations.
The CFPB, which Congress created as part of the 2010 Dodd-Frank Act, has jurisdiction over payday lenders, and the rules it proposed would apply regardless of where the lenders were located. . These rules would extend to short-term loans an important principle that Dodd-Frank has applied to mortgages: with one notable exception, lenders must ensure that a borrower can repay them before issuing the loan. Today, payday lenders simply verify that an applicant has a paycheck and checking account, which they draw directly from to withdraw the full loan amount and fees when they are due. According to the proposal, lenders should take into account the borrower’s full financial situation, including other debts and living expenses.
You would think that lenders would make this kind of “guarantee” anyway, but payday lenders don’t because they can extract payment from the borrower’s account before other creditors. And if the borrower’s checking account doesn’t have enough to cover the debt, lenders usually roll over the principle into a new loan and add more fees. Such bearings are common; more than half of payday loans are issued in sequences of 10 or more consecutive loans.
Some consumer advocates to complain that the exception in the proposed rules would allow payday lenders to make up to six loans to a borrower per year without verifying their ability to repay. But this option is designed to ensure that credit remains widely available. And to prevent these loans from becoming debt traps, the rules would prevent them from being rolled over into new loans unless the borrower repays at least a third of the amount owed, with no more than three consecutive loans allowed. This restriction could expose payday lenders to more defaults, but it would have the welcome effect of encouraging them not to make loans that cannot be repaid on time.
The main complaint from payday lenders is that the proposal “creating financial havoc in communities” by eliminating a huge amount of short-term loans. But as states that have banned payday loans have found, more affordable alternatives are emerging as payday loan storefronts disappear. The bureau’s proposal also aims to pave the way for longer-term loans with less blatant interest rates that are better suited to people who cannot afford to repay a loan in full within 45 days. This is an area that state and federal policymakers should also focus on, so that better and safer alternatives emerge for the millions of people who have been payday loan customers simply because they have no financial means. other choice.