I had a hallelujah moment when I saw that the Consumer Financial Protection Bureau is proposing rules that would require payday lenders to make sure borrowers have the means to repay their loans.
I know. You must be thinking what I’ve thought for years: Isn’t it the responsible thing for lenders to determine that people can pay the money back?
But because many people are still in a financial bind after paying off the loan, they end up taking out another loan. Repeat borrowing is good business for the lenders. The CFPB found that more than 80 percent of payday loans are followed by another loan within 14 days.
Payday loans are relatively small and are supposed to be paid back in full quickly, typically in a few weeks. The lending requirements are pretty skimpy — a bank account and income. Borrowers can give lenders post-dated personal checks or authorize an electronic funds withdrawal. The typical customer spends five months on the payday hamster wheel and pays $520 in fees for an original loan of $375, according to findings from the Pew Charitable Trusts, which has been doing great research on the dangers of these types of loans.
Payday loans are big business — $7.4 billion annually, according to Pew. Each year, 12 million Americans take out such loans from storefront locations, Web sites and a growing number of banks.
The CFPB proposal pertains to other types of loans, too, including auto title loans, in which people borrow against their paid-off cars. If a customer fails to repay a title loan, the lender can repossess the car. In a recent report, Pew said that more than 2 million people use high-interest automobile title loans, generating $3 billion in revenue for lenders. The average title loan is $1,000. The average borrower spends an estimated $1,200 a year in fees.
The businesses that peddle these loans say they are providing a needed service. And even some payday clients I’ve talked to see it that way — or at least many did at first. The regrets come later.
“Most people aren’t looking for credit,” said Nick Bourke, director of the small-dollar loans project at Pew. “They are looking for a financial solution for a persistent financial problem.”
Under the CFPB’s proposal, lenders would have to look at a person’s income and other financial obligations to determine his or her ability to pay the interest, principal and fees. The agency is also considering imposing limits on how many loans a customer can take out in a year.
“For lenders that sincerely intend to offer responsible options for consumers who need such credit to deal with emergency situations, we are making conscious efforts to keep those options available,” CFPB Director Richard Cordray said. “But lenders that rely on piling up fees and profits from ensnaring people in long-term debt traps would have to change their business models.”
What the agency is proposing has the ingredients for good reform, according to Bourke and other consumer advocates, such as Consumers Union and the Consumer Federation of America. But they are concerned about a loophole that lenders may exploit. The proposed rule includes a provision allowing a small number of balloon-payment loans that wouldn’t have the ability-to-repay requirement, Bourke pointed out.
“None of this is set in stone, but giving lenders the option to make three loans in a row without requiring a straightforward, common-sense ability-to-repay review should not be part of a final rule,” said Tom Feltner of the Consumer Federation of America.
I understand that people can get into a financial jam. But if a short-term loan product weren’t available, they might manage their money in a way that doesn’t trap them into more debt.
Pew found that both payday and title-loan borrowers usually have other options, including getting the money from family or friends, selling possessions or cutting back on expenses.
“Actually we found a large percentage end up using one of those options to get out from under the payday loans,” Bourke said.
Payday and title loans are the very definition of robbing Peter to pay Paul. Consider these facts from Pew:
● The average lump-sum title loan payment consumes 50 percent of an average borrower’s gross monthly income.
● A typical payday loan payment takes 36 percent of the borrower’s paycheck.
Borrowing against a future paycheck or putting up the title to your car can cause a financial avalanche. Even with better protections, just don’t do it.
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A typical payday loan payment takes 36 percent of the borrower’s paycheck.