Payday Lenders, High Cost and High Risk Loans Need Alternate Thinking

Payday lending, like credit card interchange, typically get a bad rap.  In the interchange issue, merchants tend to posit that the payments system should be free, despite the fact that MasterCard and Visa own the private system and provide services that increase spending,  reduce theft and provide convenience to all.  In payday lending, short term loans are made, typically around $500, to high risk borrowers who have nowhere else to borrow.  Rates often annualize around 400%.

• Faced with the opportunity to protect Americans from payday lenders and their 400 percent interest rate loans, a majority in the U.S. House of Representatives instead chose to side with America’s legalized loan sharks and give them special protections for their dangerous products

• Those who voted for stripping CFPB of enforcement authority are giving payday lenders keys to circumvent state laws and other protections put in place by the public directly

This borrowing contingent is one that has nowhere else to go.  In most states it is highly regulated.  As an example, in the state of Florida, the maximum allowed from a payday lender is $500, and you are required by law to pay a $1.00 fee to the state who tracks your social security number to ensure that only one loan is outstanding per person.  Unlike many states, 24 hours must pass before you are allowed another loan.  This prohibits the creation of perma-debt situations where the loan never gets paid in full.

• “This was a vote to take the lifeguard off the beach and let loose an industry that harms millions of families,” said Jessica Juarez Scruggs of People’s Action. “Anyone watching the House in action today would have seen a master class in how Congress really works – for those with the money to buy what they want.”

• The typical interest rate of a payday loan is 391 percent APR, and payday lenders make 75 percent of their profits off of consumers with more than 10 loans each. Because payday lenders collect directly from a borrower’s bank account, payday lenders can remain profitable even when borrowers cannot afford to repay them without defaulting on other financial obligations.

There are some valid concerns.  Anecdotal issues often arise where customers around military bases get caught in the loop of renewing and creating multiple accounts, a nightmare for many households who are already on the fringe of financial peril.

This industry needs one of three solutions:

1. Outlaw the entire business of payday lending, which will end the channel for the credit impaired.
2. Establish consistent guidelines, not state specific rules but one national standard, that forbid renewals, create consistent lending caps and tighten up the lending requirements, which will reduce available credit
3. Create a publically funded pool to serve this channel, with low margins, and the ability to seize tax refunds and other social benefits if the customer defaults.

Some banks have attempted to serve this contingent but the lending terms are not compliant with accepted banking margins.  But, at the same time, when you consider the cost of a bounced check fee, often $30, which could occur on a $1.00 overdraft, payday lenders do not stand alone as the highest cost lender.

Overview by Brian Riley, Director, Credit Advisory Service at Mercator Advisory Group

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