Payday loans are advertised as a quick and easy solution to temporary cash flow problems. In reality, for most borrowers, the payday lending experience rarely ends up being easy or temporary.
Most take out these small-dollar loans to meet monthly or recurring expenses, which don’t go away after the initial loan. Because few borrowers experience a change in economic circumstances before the loan is due, most have to take out another loan or incur fees to postpone repayment. Research from the Consumer Financial Protection Bureau says that 82 percent of loans are renewed within 14 days.
By severely limiting the payday loan industry, the CFPB’s proposed new rules are intended to put an end to the “debt trap” far too many economically vulnerable borrowers struggle to escape. This is a responsible and appropriate response from the agency charged with protecting the best interests of American consumers, but Congress has responsibilities as well.
In addition to direct changes to industry rules, economic policies that broadly help to promote full employment and higher wages would go a long way toward reducing demand for payday loans in the first place. This includes policies such as raising the minimum wage and eliminating the tipped wage. Increasing the federal minimum wage to $12 by 2020, for example, would lift wages for as many as 35 million workers and increase incomes by roughly $2,300 a year for the average affected worker.
Other policies that will help to boost wages for low- and moderate-income earners include strengthening rights to collective bargaining, regularizing undocumented workers, ending forced arbitration and securing workers’ access to sick leave and paid family leave, as well as eliminating race and gender inequities in employment and pay. One of the best ways to provide a boost for low-wage workers is to pursue full employment by keeping interest rates low until wage growth picks up, or even by enacting employment programs targeting the hardest-hit communities. Public and nonprofit employment programs, for example, support full employment by creating jobs that are accessible to those facing significant barriers to employment and improving the quality of life and physical infrastructure in local communities.
Congress could also act by setting a non-predatory APR cap, similar to the 36 percent cap set for members of the military in the Military Lending Act of 2006. They could also pass legislation making the government a provider of emergency finance for the poor through the U.S. Post Office, as some have suggested.
Yet the continued proliferation of payday lenders makes clear that there is demand for the services they provide. The chronically cash-strapped clientele that payday lenders thrive on disproportionately includes those making less than $40,000 per year — often people with less than a bachelor’s degree and African Americans. Imposing stricter regulations on the market or directly entering the market as a provider are both examples of how the government can intervene in the way in which these loans are supplied. Raising wages, on the other hand, would actually reduce demand for payday loans.
There is no question that the predatory nature of most payday loans puts pressure on people who are already in economic difficulty. The advertised temporary nature of these loans contradicts the reality of what allows the payday lending business model to thrive. According to the Federal Reserve Bank of Kansas City Economic Research Department, “the profitability of payday lenders depends on repeat borrowing.”
Lenders usually charge the equivalent of nearly a 400 percent APR — a rate that would be prohibited were it not for exemptions to state laws prohibiting small-dollar loans and to usury interest rate caps. Existing regulations vary widely by state, and a consistent set of federal rules would help to eliminate abuse.
Assuming the industry isn’t going anywhere, setting rules that protect borrowers is the responsible thing to do. Raising incomes, however, gets us much closer to addressing the problem rather than simply treating the symptoms.