The Washington PostDemocracy Dies in Darkness

The payday industry’s money-making model is coming to an end

Consumer Financial Protection Bureau Director Richard Cordray, center, listens to comments during a panel discussion in Richmond, Va., Thursday, March 26, 2015. Payday lenders would face federal rules aimed at protecting low-income borrowers from being buried by fees and debts under proposals being unveiled Thursday by the Consumer Financial Protection Bureau. (AP Photo/Steve Helber)
Placeholder while article actions load

The payday lending industry markets itself as a helping hand for customers dealing with a short-term cash crunch or one-time emergencies. Lending ads frequently depict dented cars, flat tires, mothers looking worriedly at bills. “We understand that you may be in a tough situation, and we’re here to get cash in your hands quickly,” one major lender, Speedy Cash, says on its Web site.

But the U.S. government’s consumer protection agency says such loans are too rarely a one-time thing. After the original loan is taken out, fees mount. Cash-strapped borrowers face debts they can’t afford. They take out new loans to pay for those debts. And the debts mount further, forcing a cycle of repeat borrowing — and escalating fees — that the industry depends on to make its money.

In his weekly address, President Obama talks about consumer protections and takes aim at payday loans. (Video: Reuters)

The Consumer Financial Protection Bureau’s new (and preliminary) regulations for payday lending mark an attempt to call the industry on its own rhetoric. In short, the rules, as written, attempt to force the short-term loans to actually end in the short-term.

Under these rules, unveiled Thursday, borrowers could take out an initial payday loan. And then, as that one becomes due, another one. And then a third.

And that’s it.

The notion of a back-to-back-to-back payday loan may sound extreme, but it’s actually a fairly average outcome for a borrower. The CFPB’s goal, you might say, is to eliminate the outcomes that are even worse than that.

According to CFPB data, 40 percent of borrowers take out only one loan. (A sliver of those, it should be mentioned, default rather than make the full repayment.) About 15 percent take out two loans in sequence. The remaining 45 percent take out three or more. And a full 14 percent takes out more than 11 loans in a row. For that portion, a credit product marketed as a two-week cash advance turns into months of debt, as seen in the CFPB data below.

Because they take aim at this pillar of the payday industry’s business model, the new CFPB rules “could shift the market pretty substantially,” said Gary Kalman, an executive vice president at the Center for Responsible Lending.

Consumer advocates say borrowers often have little choice about using second and third payday loans to pay for original ones. That’s because borrowers secure their loans by giving lenders either a personal check or authorizing access to a bank account. Once the next paycheck comes in, the lenders collect the money—which might leave borrowers with nothing left to cover other expenses, like mortgage or bill payments.

At a hearing Thursday in Richmond to discuss the industry and the CFPB proposals, several payday lending officials said the potential regulation was excessively harsh, and risked choking off credit to low-income consumers who are poorly served by banks. They also defended the pattern of repeat loans, saying that multiple loans in succession don't necessarily signify a borrower in distress.

“Re-borrowing is a decision made by a consumer and simply a matter of choice,” said Edward D’Alessio, executive director of the Financial Service Centers of America, a trade association.

Under the CFPB guidelines, lenders would have to obey a 60-day “cooling off” period after the third consecutive loan to a borrower. In its recent federal filings, QC Holdings, Inc., a public company that operates some 400 lending branches across the country, described such “cooling off” regulation as one of the “risk factors” to its business. QC Holdings said its payday loan customers in 2014 on average took out six two-week payday loans.

Richard Cordray, the CFPB director, said Thursday in Richmond that it was irresponsible to extend credit in a way that sets up borrowers to fail and “ensnares considerable numbers of them in extended debt traps.”

“Consumers need credit that helps them, not harms them,” he said. “If the lender’s success depends on the borrower failing, market dynamics are not functioning properly.”