By Brett Husak
National Bank Services
Perhaps you've heard about payday loans: the unsecured, short-term loans that typically become due by the borrower's next payday. Some may be unfamiliar with this business practice because it is outlawed in 14 states; others may be aware of it and consider it to be a cringe-worthy, predatory lending practice. While some people may view this industry with contempt, millions of customers who utilize these services see it as a necessity. This article shares facts about payday loans, gives clarity to current legal attacks on the industry, and brings to light why this is important to every American.
There are over 20,000 payday loan locations in the United States. That is more locations than Starbucks or McDonald's. Allow that to sink in. According to a recently updated fact sheet from The Pew Charitable Trusts, 12 million people pay approximately $9 billion per year in payday loan fees. It's also true that the finance charge for payday loans is very high: $10 to $30 per $100 borrowed. That is the equivalent of an annual percentage rate (APR) of around 400 percent. In contrast, the average credit card APR averages from about 12 to 30 percent. However, the average payday loan size is about $375 and the average loan term only two weeks.
Payday loans have been used predominantly by the low-income, less financially secure portion of the population. The key concerns of the federal government have been the interest rates and lending practices of these businesses. Most states share these concerns and acknowledge that regulation of this sector is needed.
Some states have already censured payday loan businesses for their high interest rates; other states have allowed them to basically self-govern. That may be about to change. In June 2016, the Consumer Financial Protection Bureau released a set of proposed regulations for the payday loan industry. You can read the 1,334-page release or, if you have other plans for the week, examine the fact sheet here: http://files.consumerfinance.gov/f/documents/CFPB_Proposes_Rule_End_Payday_Debt_Traps.pdf.
The CFPB is proposing major rules to eliminate what it identifies as "debt traps." The first requires that lenders attempt to ensure that consumers will be able to repay their loans; the other eliminates repeat borrowing practices that increase fees. The bureau is concerned that when borrowers face elevated payments, they may be forced to choose between "reborrowing" the loan (paying new fees to extend the original loan), defaulting, or neglecting their other financial obligations like housing costs or essential living expenses.
Under this proposal, lenders would be required to determine if the borrower can repay the full amount of each payment and still cover all other monetary responsibilities throughout the term of the loan ‒ and for an additional 30 days after repayment. Lenders would be expected to accomplish this by verifying a potential borrower's income and checking the individual's credit report to search for outstanding debts.
CFPB research has shown that four out of five short-term loans are reborrowed within a month. This occurs when a loan is renewed once it has become due or when a borrower takes out a new loan soon after the first one has been repaid. More fees and interest are added to the loans each time they are reborrowed. A majority of these short-term loans are borrowed by consumers who take out a minimum of 10 consecutive loans. To prevent people from falling into such debt cycles, the CFPB has proposed rules to prevent lenders from promoting these practices.
Lenders would be forbidden to rollover loans or to offer loans to borrowers who return seeking another within 30 days after repaying a debt. A similar short-term loan could only be extended to consumers who could prove that their financial situations would be improved during the term of the new loan. The same assessment would have to be made if a third loan were requested. Finally, requests for successive loans would be capped at three, which would be followed by an obligatory 30-day waiting period.
Following are sources used in researching this article:
Payday loans are a $46 billion industry, which these rules could severely impair. Additionally, the economic ripple effects of this cannot be predicted. These rule changes could reduce short-term lending by an estimated 60 percent. The increased paperwork required would also place a significant administrative burden on lenders.
Payday loans may be a necessary evil, one that is not generally admired but that serves a purpose. Many people living paycheck to paycheck depend on these types of loans, and while some may default or be unable to recover financially, many others do not. Although its intent is positive, the CFPB proposal has sparked political debate that will last for months before final regulations are enacted.
The CFPB is only the latest group to play a part in a government attack on payday loans. Consider Operation Choke Point, which began in 2013. That may sound like the title of a comeback movie for Jean-Claude Van Damme. Unfortunately it's not. Instead, it's a partnership initiative between the U.S. Department of Justice and the Financial Fraud Enforcement Task Force, a coalition of agencies established to thwart financial fraud.
Operation Choke Point aims to suffocate businesses in select industries by blocking them from financial services such as payment processing, effectively "choking" the flow of money the businesses need to survive. The most unsettling thing is that Operation Choke Point asks banks and third-party payment processors to decline service to industries that are considered to be "reputation risks," but most of which are completely legal businesses.
Mixed into the undesirable list with Ponzi schemes and escort services are tobacco and firearm sales, dating services, coin dealers, and, yes, payday loans. Most business owners and American citizens view this as excessive overreach by the government into private industry. They may be held in low regard, but they have the right to operate under the law and should not be held to an arbitrary moral compass.
In February 2016, the House passed the Financial Institution Customer Protection Act, which would in effect shut down Operation Choke Point. It requires federal regulators who wish to close a customer's account to submit written requests to banks with an explanation and material reason for its termination. It will still need to pass the Senate and be signed by the President before it can become law.
Business owners and consumers alike might find this level of government involvement in the free market disconcerting. Everyone can agree there must be a way for the large segment of our country's population using payday loans to continue to be served. Many may also agree that some sort of oversight is the answer to protect these people.
However, the CFPB's proposed regulation and Operation Choke Point share an objective: to cut off the flow of money that keeps lenders in business. The CFPB's proposal is viewed by many to be less of a regulation and more of an obliteration of an industry. It will be interesting to see how this develops as it becomes more politicized and more public.
Brett Husak is Director of High Risk Merchant Services at National Bank Services. He can be reached at firstname.lastname@example.org.
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