Mike Calhoun is president of the Center for Responsible Lending.
The Consumer Financial Protection Bureau’s proposed rule requiring payday and car title lenders to assess borrowers’ ability to repay will, by all projections, reduce the number of these loans being made. The question often comes up: What will those consumers who might have taken out a payday or car title loan do instead?
A review of the credit market for households with lower credit scores and the experience of states that have addressed payday lending show that many alternatives are available. They are all far better than the long strings of repeated high-cost loans that trap payday borrowers in unmanageable and ultimately devastating debt.
Subprime credit cards, even with interest rates at 36 percent APR, are one-tenth as expensive as payday loans. After a temporary constriction in this market following the financial meltdown, new subprime credit card accounts have increased every year since 2009. They surged in 2015, with more than 10 million new cards issued to subprime borrowers, up 25 percent from a year earlier. In total, subprime consumers have 62 million credit card accounts.
Traditional consumer finance companies market installment loans to subprime credit households. They offer more credit than payday lenders, and their volumes increase when payday lenders don’t crowd them out. Data from publicly traded lenders show they made $7 billion on these loans in 2013, and privately held lenders made billions more.
Additionally, 700 federal credit unions participate in the National Credit Union Administration’s “payday alternative loan” program, making loans up to $1,000 that last up to six months long. Banks and credit unions also originated 3.8 million unsecured installment loans to nonprime consumers (credit scores below 660) in 2015. Importantly, payday loan borrowers are not among the nation’s “unbanked” consumers; lenders require that they have a checking account from which the lender can extract payment.
In dire circumstances, even pawn loans are better than payday loans. They are cheaper and, unlike payday loans, there is an exit strategy if the borrower can’t repay: The lender keeps the pawned item, and the borrower walks away, owing nothing further. Though families may give up the pawned item, they are not trapped in a series of 400 percent interest payday loans that can lead to much worse losses — abusive debt collection tactics, the loss of a car or filing for bankruptcy, to name a few. There are more than 11,000 pawn storefronts nationwide with more than 30 million customers.
Finally, utilities and other companies often offer affordable payment plans to those who have trouble keeping up. Indeed, payday borrowers frequently turn to these and other alternatives to ultimately pay off their payday loans.
In evaluating these alternatives, it is important to keep in mind that most payday loans do not provide new credit; they just flip previous payday loans. More than 4 out of 5 payday loans are taken out within the same month as the previous unaffordable payday loan. Payday lenders have the right to seize the borrower’s bank account on payday, so they get their money but often leave the borrower without enough money to pay other essential expenses. The lender then makes another payday loan to cover these expenses, and the cycle of debt continues. In other words, payday loans generate their own demand; the business model is built on creating a debt trap, not meeting credit needs.
More than 90 million Americans live in states without payday lending, and these consumers are served by these and other alternatives. And this has long been true throughout the country, as payday lending did not exist in any state until these lenders starting getting special exemptions from state usury laws 20 years ago. They did so on the purported basis that their high rates were for a single short-term loan to address a once-in-a-blue-moon emergency — not the long-term debt traps they actually are.
The critical issue with the CFPB’s proposed rule is not where borrowers will go; as shown above, there are many alternatives. Rather, the core issue is whether the rule will be strong enough to require payday lenders to stop their abusive practices and start making loans borrowers can afford. The proposal takes the right approach with its common sense “ability-to-repay” principle, but significant loopholes must be closed to ensure the rule fulfills the CFPB’s congressional mandate to ensure financial practices do not inflict substantial harm.