The online lending industry is currently in a state of change. New rules and regulations are being proposed. More people than ever before are speaking up. Powerhouse websites are banning payday lending advertisements. Big changes are looming overhead … or at least the promise of big change.
The Consumer Financial Protection Bureau (CFPB), “helps consumer finance markets work by making rules more effective and by consistently and fairly enforcing those rules.” They recently proposed new rules for the payday lending industry which have stirred up much conversation. To understand why they’re proposing these new rules, it’s important that you first understand the payday lending industry.
This video explains payday loans: what they are and how these shortterm loans become longterm debt traps. To fully understand the current state of the payday lending industry, though, we must first understand the past: how this industry came to be and how it has evolved through the years.
A Look Into the Past
The first form of payday lending first appeared over a century ago. This was before the mass market for consumer credit, that we have today, existed. According to a report by The Pew Charitable Trusts, these “salary lenders” offered one week loans with 120500% APR. The lenders were illegal and would use tactics like extortion, public embarrassment, and wage garnishment for repayment.
Fast forward to the mid20th century. The mass market for consumer credit began to emerge and so did the demand for it. As the demand for fast credit grew, it laid the perfect foundation for the growth of the payday lending industry. The payday lending industry grew exponentially throughout the early 1990s and into the first part of the 21st century, which brings us to today.
Today: The Current State
The payday lending industry is larger than ever. According to Jonathan Zinman, an economist at Dartmouth, in 2008, payday loan stores nationwide outnumbered McDonald’s restaurants and Starbucks coffee shops, combined. Since then, the payday lending industry has continued to grow. According to the Consumer Federation of America (CFA), at the end of 2010, there were nearly 20,000 payday loan stores; that doesn’t even include online lenders, which have grown exponentially in the past few years.
So, what does this look like for the consumer?
With average interest rates currently around 400% APR or higher, the payday loan borrower quickly gets stuck in what’s known as the payday loan debt trap. Studies have found that the average payday loan borrower takes out 8 loans per year, with every 4 out of 5 payday loans being either rolled over or renewed within 14 days. The CFPB began researching payday loans nearly four years ago. Since then, one of their biggest findings has been that most consumers who take out payday loans cannot afford to pay them back by their next paycheck. Through their research, they’ve also found that 1 in 5 new borrowers ends up taking out at least 10 or more loans, one after the other. The issue with payday loans isn’t just their short repayment period (typically 2 weeks), though.
In their research, the CFPB also found that bank penalty fees and account closures are a significant hidden cost of online payday loans. With access to borrowers’ checking accounts, online lenders make repeated attempts to debit payments from the account. This adds significant costs and additional fees to the true cost of online payday loans. The CFPB found that half of online borrowers are charged an average of $185 in bank penalties. These fees are additional costs that are incurred above and beyond the fees that payday lenders charge. The fees charged by payday lenders can be quite devastating, as well. For every 3 out of 5 payday loans, borrowers end up paying more in fee expenses than the total loan amount owed.
Payday loans aren’t created to provide shortterm relief for borrowers. They’re created to be traps. Lenders only make money when borrowers continue taking out new loans and accruing fees and interest. So, it’s in the lender’s best interest to ensure the loans they’re providing aren’t affordable for the average borrower. According to Richard Cordray, the consumer agency’s director, “The very economics of the payday lending business model depend on a substantial percentage of borrowers being unable to repay the loan and borrowing again and again at high interest rates. It is much like getting into a taxi just to ride across town and finding yourself stuck in a ruinously expensive crosscountry journey.”
Frustrations with the current state of the online payday lending industry, and their rules and regulations, have become more vocalized in recent months. Consumer advocates and groups are standing up and voicing their opinions. They’re demanding change. And so are others.
When Giants Stand Tall
As big changes loom over the payday lending industry, a powerhouse website recently announced they would be banning payday lending advertisements. In May, the search giant “Google” announced that they would no longer allow payday loan companies to advertise on their site. According to Forbes, Google’s Director of Global Product Policy, David Graff, said, “This change is designed to protect our users from deceptive or harmful financial products.
Research has shown that these loans can result in unaffordable payment and high default rates for users…”
While it isn’t unusual for Google to restrict companies that can run ads, this is a very surprising move. According to Forbes, last year Google disabled more than 780 million ads related to illegal offers like weight loss scams, counterfeit goods, and phishing sites. However, their move to ban payday loan ads is different, because payday loans are legal.
Many consumer advocates are applauding Google’s decision as the right thing to do. We’ve all seen the movies and heard the stories of the respected hero standing up to the bullies of the playground. It sets a precedent for how things are to be handled both on and off the playground. It sends a message. When giants stand tall, change is inevitable.
Change is near!
While more than a dozen states have set rules and regulations to cap and/or prohibit payday loans, the industry continues to thrive in more than 30 states.
In June, the CFPB announced a proposed rule that would end payday loan debt traps. The proposed rule would offer relief to borrowers and hold payday lenders accountable. There are several significant changes that the rule proposes:
1. It would require that before approving a loan, a lender “must reasonably determine that the consumer has the ability to repay the loan.”
“The lender would have to make a reasonable determination that the consumer would be able to make the payments on the loan and be able to meet the consumer’s other major financial obligations and basic living expenses without needing to reborrow over the ensuing 30 days.” The proposal lists various factors a lender must verify before making this determination.
2. It would cut off repeated debit attempts that rack up fees and make it harder for consumers to get out of debt.
The new proposed rules states that, “The proposal also would identify it as an unfair and abusive practice to attempt to withdraw payment from a consumer’s account for a covered loan after two consecutive payment attempts have failed, unless the lender obtains the consumer’s new and specific authorization to make further withdrawals from the account.”
3. It would reduce the number of times someone could roll over their loans.
Mike Calhoun, the President of the Center for Responsible Lending, says that “At the heart of this proposed rule is the reasonable and widely accepted idea that payday and car title loans should be made based on the borrower’s actual ability to repay – while still meeting other basic living expenses.” These changes don’t come without an expense to the payday lending industry, though. According to this article by the NY Times, the proposed rules would radically reshape
the market. It is estimated that loan volume could fall at least 55% and the $7 billion that lenders collect in fees, yearly, would drop significantly.
As with any push for change, there’s always more than one side. The Community Financial Services Association of America, a national organization for payday lenders, argues against a cap on payday loan interest rates. Amy Cantu, a spokeswoman for the association, argues that price fixing “almost always results in reduced consumers access to any product.” She also said that, “in the absence of regulated, licensed storefront lenders, many consumers turn to unregulated, unlicensed lenders that operate online.” She argues that if payday loans are eliminated, we’re still left with the question of where these consumers will go for shortterm credit needs, because these needs don’t just go away.
However, the CFPB has made suggestions for several alternatives that wouldn’t leave consumers without access to cash when they need it. Loans less than $500 could be issued without requiring the lender to assess the borrower’s ability to repay, as long as various conditions are in place to ensure a consumer cannot get stuck in debt. A second alternative would be longerterm loans with interest rates less than 28%. You can watch this video to know more
The Future: What’s Next?
The CFPB will be collecting comments on the proposed rules through this fall. For now, the industry remains on edge as we await the final decision on the proposed rules. One thing is for sure, though. The online payday lending industry is currently on the cusp of big change. More people than ever before are speaking out from both sides. Online website giants are standing up for consumer rights. And as with all change, the future is uncertain.