Payday Loans are unsecured, short-term loans that typically become due by the borrower’s next payday. Some people may be completely unfamiliar with this type of business because it is outlawed in 14 states. Others may be aware of it and consider it to be a cringe worthy and predatory lending practice. Although it is often viewed with contempt, it is likewise a necessity for the millions of customers who utilize these services. And it is currently under attack from the federal government. This June, the Consumer Financial Protection Bureau (CFPB) released a set of proposed payday loan regulations that will have a great impact on the industry and could have even bigger implications on the free market.
To understand their popularity, you need to know there are over 20,000 payday loan locations in the United States with more than 14 million people borrowing over $7 billion per year. This has historically been a service used by those who are considered low income and less financially secure. The key concerns of the federal government have been on the interest rates and lending practices of these businesses. Most states feel the same way and acknowledge that regulation of these practices is needed. It is true that the finance charge for payday loans is very high. It can cost between $10 and $30 per $100 borrowed. That is the equivalent of an annual percentage rate (APR) of around 400%. In contrast, the average credit card APR is about 12% to 30%. However, the average payday loan size is about $375 and the average loan term only 2 weeks.
The CFPB proposed rule changes aim to eliminate what they deem to be “debt traps”. The first requires that lenders attempt to ensure that consumers will be able to repay their loans. A major concern of the CFPB is that when borrowers are faced with elevated payments, they may be forced to choose between “reborrowing” the loan (paying new fees to extend the original loan), defaulting, or neglecting their other financial obligations like housing costs or essential living expenses. Under this proposal, lenders would now be required to determine if the borrower would have enough money to repay the full amount of each payment and still cover all other monetary responsibilities throughout the term of the loan and for an additional 30 days after repayment. This would need to be accomplished by verifying a potential borrower’s income and also doing a credit check for any outstanding debts.
The other major proposal would eliminate repeat borrowing practices that increase fees. Research done by the CFPB has shown that 4 out of 5 short term loans are “reborrowed” within a month. This occurs when a loan is renewed once it has become due or when a borrower takes out a new loan soon after the first one has been repaid. Of course, more fees and interest are added to the loans each time it is reborrowed. In order to prevent people from falling into cycles of debit, the CFPB has recommended rules that forbid lenders to rollover loans or to offer loans to borrowers who return within 30 days after repaying a debt. A similar short term loan could only be extended to consumers who could prove that their financial situation would be improved during the term of the new loan. Requests for successive loans would be capped at 3 which would be followed by an obligatory waiting period of 30 days. It is estimated that these rule changes could reduce short term lending by 60%.
Of course the CFPB is only the latest group to play a part in the government attack on payday loans. Operation Choke Point, their more controversial predecessor, began in 2013. That may sound like the title of a comeback movie for Jean-Claude Van Damme but unfortunately it is not. Instead, it is a partnership initiative between the U.S. Department of Justice and the Financial Fraud Enforcement Task Force (FFETF), a coalition of agencies established to thwart financial fraud. Operation Choke Point is aptly named because it aims to suffocate businesses by blocking them from financial services, effectively “choking” the flow of money the businesses would need to survive. The most unsettling thing about Choke Point is that it is asking banks and third party payment processors to decline service to industries that are considered “reputation risks” but most of which are completely legal businesses. Mixed into the undesirable list with Ponzi schemes and escort services are tobacco and firearm sales, dating services, coin dealers, and payday loans. This is viewed by most business owners and American citizens alike to be excessive overreach by the government into private industry. Even if they are attacking companies that many people hold in low regard, they have the right to operate under the law and should not be held to an arbitrary moral compass.
Business owners and consumers alike might find this current level of government involvement in the free market disconcerting. Everyone can agree that some sort of oversight is needed to protect the large segment of our country’s population using payday loans. However, measures like those of the CFPB and Operation Choke Point are the same: to cut off the flow of money that keeps lenders in business. This is viewed by many to be less of a regulation and more of an obliteration of a 46 billion dollar industry. Additionally, the economic ripple effects this would cause cannot begin to be predicted. This debate has become even more politicized and contentious over the past few months. The CFPB has encouraged the public to submit comments up until October 7th. So far they have received over 172,000 replies mostly from people who are concerned about losing their credit access.