Payday lenders will face a defining moment when the Obama administration releases new regulations for their industry in the coming months. Trade groups and members of Congress say those regs could shutter many businesses.
The Consumer Financial Protection Bureau is expected to propose a rule this month or next to protect hard-up borrowers from falling into a “spiral” of mounting, expensive payday debt.
The rule would fulfill one of the main motivations for the agency, a creation of the 2010 Dodd-Frank financial reform law reviled by Republicans. It is also likely to test whether the government can protect vulnerable people from abusive lending services without depriving them of access to emergency credit.
The core of the rule will be an attempt to prevent a “spiral” of payday borrowing. This occurs when borrowers paying high fees on payday loans fall behind on other bills and turn again and again to payday loans to make ends meet.
In an interview with the Washington Examiner, Dennis Shaul, the CEO of the main industry group the Community Financial Services Association of America, said borrowers who constantly roll over payday loans are a “blight on the industry.”
The problem, as indicated by the consumer bureau’s own studies, is that a significant portion of payday customers are in a prolonged period of intense use.
The way payday lending works is that the lender disburses a small cash loan while holding onto a postdated check or getting access to the borrower’s bank account. The borrower uses the cash to meet some short-term need, and then repays it, along with a fee, once his paycheck comes or has the lender claim the money by cashing the check or withdrawing directly from his bank account.
The trouble begins because 80 percent of payday loans are rolled over or followed by another loan within 14 days, according to the bureau’s research, and half of all loans made are part of a loan “sequence” of at least 10 loans.
To look at the phenomenon another way: The typical borrower takes out 10 loans in a given year and pays $458 in fees, the agency found. Each time, he or she is borrowing a median of $350.
Translated to an annual percentage rate, the fees on paycheck loans work out to an interest rate of more than 300 percent, compared with a typical credit card interest rate of 16 percent. Usually, when the loan is paid off, the payment amounts to about a third of the borrower’s paycheck.
The typical payday borrower who takes out a string of high-cost loans is someone who has a job and a bank account and earns less than $30,000 a year. He turns to a payday loan for an emergency, usually a situation in which he is willing to pay a steep price in the short term to avoid a much worse outcome. But for these people, that emergency might be what most would consider routine, such as paying the electricity bill. And it might be an emergency lasting for months.
To payday critics, what is “particularly jarring about payday loans is that they affect millions of workers who are by all accounts doing everything right” but lack economic security, said Tom Mulloy, a policy adviser for the U.S. Conference of Catholic Bishops. “In that insecurity, some bad actors step in and exploit it rather than provide assistance.”
Evidence shows that payday lending is a last resort. Many people have no financial buffer: Half of Americans could not come up with $400 in cash in an emergency, according to Federal Reserve data. Surveys indicate that payday borrowers have exhausted their ability to borrow from family and friends. And industry data suggest that fewer than 1 percent of banks and credit unions offer loans of $500 or less, because it’s not worth the trouble.
Some studies suggest that people lose access to credit when payday loans are restricted. In that case, they might turn to worse alternatives, including bouncing checks, going over their credit card limit, pawning an item or going to an illegal loan shark.
The consumer agency is considering alternatives aimed at providing people from falling into a streak of expensive borrowing without cutting them off from legitimately needed credit.
One option would be to allow for short-term loans of under 45 days if lenders verify the borrowers’ ability to repay or cap loans at $500 and limit borrowers to three consecutive loans and no more than 90 days of indebtedness a year. That option would give borrowers an ability to “taper” the amount they are in debt rather than see it spiral.
Another option would be to allow longer loans, but cap fees so that the loan has an annual percentage rate of 36 percent maximum. Or, the agency could mandate longer loans that limit payments to 5 percent of the borrower’s monthly income, with durations of no more than six months and no fees for prepayment of the loan.
Analysts warn that some variations of those rules could put most of the industry out of business. The 36 percent interest rate cap, for instance, translates to charging a $1.38 fee per $100 borrowed every two weeks.
Ability to repay is a guideline that the consumer agency has instituted in major rules for mortgages and other forms of consumer credit in the wake of the financial crisis. But Shaul warned that the agency is considering a version of ability-to-pay rules that is inappropriate for the industry. It would require lenders to conduct a “residual income test,” which looks at the borrower’s ability to pay for regulator bills, food, housing and so forth in addition to the loan cost. But people turn to payday lending only when they are already struggling with those items.
Nick Bourke, a researcher at the Pew Charitable Trusts, raised a concern with the proposed ability-to-repay rules from the opposite perspective. Because lenders can collect straight from borrowers’ bank accounts, “the ability to repay in this market usually means the ability of the lender to collect,” he said. He suggested that the agency make its guidance as simple and clear as possible in the hope that banks and credit unions could step into the market, pointing to Colorado as a state that has designed rules successful in doing just that.
No matter what the agency does, it is likely to face a legal challenge from lenders and a legislative response from Congress.
Rep. Dennis Ross, R-Fla., who helped write payday lending rules as a member of the Florida state legislature, has introduced legislation to delay any agency rule from going into effect. His bill, which he already has persuaded seven Democratic colleagues to join, would give other states the option between the federal regulations and the more permissive rules in Florida.
The legislative calendar is filling up for this year, but Ross said he is hoping to see his legislation receive consideration in the Financial Services Committee, of which he is a member. “They’re going to be making an imposing financial regulation, all in the name of the consumer, that is actually going to harm the consumer,” Ross warned.
