Payday Lending Needs Better Regulation
Payday Lending Needs Better Regulation
Alexis ChapmanWednesday,8 June 2016
On June 2nd the Consumer Financial Protection Bureau (CFPB) announced proposed new rules for Payday Loans, Vehicle Title Loans, and some High Cost Installment Loans. These types of loans are all characterized by a few things: they’re generally very short term, payment is usually due by the borrower’s next payday, hence the name; they tend to be for sums of less than $500; the interest rates are very high, usually starting in the double digits and easily reaching into triple digits when fees are added and new loans are taken to pay back old loans; and these types of loans are all overwhelmingly utilized by people in lower income brackets. Because people earning less money have less access to traditional financial tools, when unexpected expenses arise Payday Loans are often the only option. Unfortunately, the high interest rates and fees and quick repayment schedules often mean that these loans become “debt traps” with people taking out one loan to pay for another and incurring much more in debt than the original loan was even worth.
These types of loans have been around for decades and the Dodd-Frank Act, which allows rule-making to regulate them, has been around since 2010, so these rules are long overdue. But it’s unclear if the rules that the CFPB is now proposing are what’s needed to reform this industry so that it works for the low income borrowers who need it. The CFPB’s actual proposal for the new rules is 1,341 pages long for some reason, but basically what is does is require Payday Lenders and Title Lenders to perform a background check on borrowers to ensure they can pay back the loan before issuing it. The rules were developed after the CFPB did research on “debt traps,” and if adopted, they will prevent certain people from taking out loans which they would never be able to pay back.
Not setting people up for financial failure is great, buuuuut — there’s always a but — the new rules still don’t address some major issues with the Payday Lending industry. For starters, most people do not get expensive payday loans on a whim; there is a genuine need for people of all income levels to have access to loans and other financial tools. If the CFPB’s rules are implemented, it’s unclear what options will be left for a potential borrower whose loan request is denied because a background check determines they’re unlikely to be able to pay back a loan. There’s also some question about who exactly the new rules will benefit the most. Small lenders may not have the resources to do the background checks and could close, thus leaving a bigger market share for larger lenders. The new rules also have some loopholes and there is some concern that predatory lenders will find a way around them. And finally the new rules don’t seem to address the biggest problem with Payday and Title Loans — the outrageously high interest rates.
One of the most perverse aspects of the way financial systems work in the U.S. is the interest rates on loans; someone who is borrowing $200,000 to buy a sports car will likely pay a pretty low interest rate, while someone who is borrowing $200 to buy food could end up paying interest over 100%. This is not because financial institutions are inherently evil (they are, but that’s not why the system is like this). The system is like this because a person who gets approved for a $200,000 car loan is probably a pretty safe bet and is likely to pay back the loan, while a person who is seeking a Payday Loan may not have any credit and is judged by financial measures as being more of a risk, so their interest rate is higher. By prohibiting lenders from lending to people who are the most unlikely to be able to pay back the loans, there is a chance that reducing the risk in the whole system will naturally cause Payday loan interest rates to fall.
There is also a much faster, more direct, and guaranteed way to ensure lower interest rates and fees on Payday loans: just cap interest rates and fees. Many states have already passed laws limiting how much can be charged for a Payday Loan. And it seems to be working. A 2014 Pew research study found that state regulations on interest rates and fees, not competition or other factors, were what determined the cost of a loan. For example one lender who operates in several states would charge the state maximum of $35 dollars for a $300 payday loan in Florida, the Alabama max of $52.50 for the same amount loan in that state, and then charge $91 for someone borrowing $300 in Texas where there is no cap. So if we actually want to solve the problem of predatory lenders we may need to be focusing less on rules targeting certain borrowers and instead set fair federal limits on the interest rates and fees charged by the lenders. If Florida can do it, then the rest of the country should be able to too.