We are a leading member of Americans for Financial Reform, a coalition that was instrumental in the creation of the Consumer Financial Protection Bureau (CFPB) by Congress in 2010. The CFPB is currently working on a rule to rein in the payday lending industry. We, along with AFR, are working to make sure the rule is a strong one. We would like to share AFR’s great explanation of payday lending and what a strong rule would look like to protect consumers from debt traps caused by these predatory products.
What is Payday Lending?
Payday loans are marketed as one time ‘quick fix’ consumer loans — for folks facing a cash crunch. In reality these loans create a long term cycle of debt, and a host of other economic consequences for borrowers. Studies have shown that payday borrowers are more likely to have credit card delinquency, unpaid medical bills, overdraft fees leading to closed bank accounts, and even bankruptcy.
Here’s How the Debt Trap Works
- In order to take out a loan, the payday lender requires the borrower write a check dated for their next payday.
- The payday lender cashes the check on that payday, before the borrower can buy groceries or pay bills.
- The interest rates are so high (over 300% on average) that people cannot pay off their loans while covering normal living expenses.
- The typical borrower is compelled to take out one loan after another, incurring new fees each time out. This is the debt trap.
The average borrower takes out 10 loans and pays 391% in interest and fees. 75% of the payday industry’s revenues are generated by these repeat borrowers. The debt trap is, in fact, the payday lending business model.
Car title and installment loans are variations on the same theme. Car title lenders use a borrower’s vehicle as collateral for their unaffordable loans. Installment loans typically have longer payoff periods and replace slightly lower interest rates with expensive, unnecessary ad-on products.
The Consumer Financial Protection Bureau (CFPB) is preparing to issue a new rule governing these high-cost loans. We are asking that payday lenders be required to make good loans. There is a pretty simple, widely accepted definition of a good loan: A good loan is a loan that can be paid back in full and on time without bankrupting the borrower. By this definition, banks and other for-profit lenders make good loans all the time.
A strong rule would:
- Require lenders confirm a borrower can repay given their income and expenses.
- Stop the debt trap by preventing long term indebtedness, as the FDIC recommends.
- Not create a safe harbor or legal immunity for poorly underwritten loans.
- Protect borrowers’ bank accounts by stopping abuses related to payday lenders’ direct access to a consumer’s checking account.
For the original text, please check out AFR’s explainer here.