The economic recovery has not benefited Americans equally. We all know that. But few facts underscore that point more clearly than the startling number of consumers whose financial futures have been put on hold by subprime credit scores.
A recent analysis released by my organization found that more than half of the nation's consumers (56 percent) have subprime scores, meaning they cannot qualify for credit or financing at prime rates when they try to get a mortgage, buy a car or take out a loan for other purposes. They also are far more likely to use costly alternatives such as payday loans.
One in five households regularly relies on these fringe financial services, according to that same study -- CFED's 2015 Assets & Opportunity Scorecard. With their astronomical interest rates averaging just under 400 percent, the vast majority of borrowers cannot afford to pay off the loans within the allotted two-week period. Instead, they are forced to roll over the loans multiple times, incurring further debt and high fees, and creating a cycle of debt.
It's hardly a surprise that the economic recovery barely registers in the lives of these families, many of whom are struggling in low-wage jobs with little ability to save or make financial plans beyond paying off their next costly small-dollar loan. Despite the perception that these loans are most often used to pay for unplanned one-time costs, a Pew study found that most (69 percent) cover recurring expenses such as utilities, credit card bills, rent or mortgage, and food.
There is wide acknowledgement that reform is needed. But given the high number of consumers with subprime credit scores, those efforts need to rise to emergency response levels.
At the federal level, the Consumer Financial Protection Bureau (CFPB) should quickly release payday loan regulations, which have been in the works for more than a year. These regulations should ensure that payday lenders are subject to underwriting standards that ensure borrowers only receive loans they can afford to pay and that they are given a minimum of 90 days to repay them. The practice by many lenders of requiring post-dated checks or authorization to automatically withdraw money from the borrower's bank account should also be prohibited or significantly limited. These practices can trigger overdraft fees for the borrowers, effectively raising the cost of the loan.
CFPB should open the way for innovation in this area as well so that payday loans aren't the only option for consumers with poor credit. This means supporting research and the evaluation of new or experimental short‐term, small‐dollar loan products that help borrowers improve their financial situation while also potentially offering a profit to lenders.
Creative small-dollar loan programs already are helping subprime consumers in communities nationwide but need to be expanded. These programs are typically offered by credit unions and nonprofits, which partner with private lenders, to provide lower cost payday alternatives to consumers with poor credit.
The programs can be life changing for consumers like Lillie Hall, who was deep in debt when she came to CommunityWorks, a South Carolina nonprofit, after her husband's work hours were reduced and she fell victim to identity theft. Hall had a good job and stable income as a community systems director for the state's Department of Health and Environmental Control, but it wasn't enough to cover the mounting bills and growing debt. When banks turned her down, payday loans seemed her only choice until she learned of the CommunityWorks credit union program, which quickly approved her for a loan at 16 percdent interest -- far below the nearly 400 percent rate charged by payday lenders. The CommunityWorks loan allowed her to start paying off debt, which had included $4,000 owed on $800 in payday loans, and reduce her monthly debt payment by $465.
Programs like CommunityWorks educate consumers about how to better manage their finances and potentially move into loan products that are more profitable for the lender. An FDIC pilot program found that banks offering affordable small-dollar loans helped build long-term customer relationships and were no more likely to result in defaults than other types of unsecured credit.
States also need to take more decisive action. Colorado banned lump-sum payday loans in 2010 and replaced them with six-month installment loans. Although interest rates remain high, total fees and interest payments over the course of a loan dropped by 42%. And credit is still available to those who need it: average loan sizes actually increased, and there were just 7% fewer borrowers.
If government leaders are serious about addressing wealth and income inequality, much needed reforms to draconian payday lending practices would be an excellent place to start. For millions of Americans struggling with poor credit, waiting is not an option.
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