NEW YORK – Lenders who advance money to the poor on their paychecks charge exorbitant interest rates that often trap the most vulnerable customers in a cycle of debt, industry critics have long said .
Yet even consumer advocates who hate the industry admit it fills a need: to provide small amounts of money quickly to people who can’t qualify for a credit card or bank loan. About 12 million Americans take out a payday loan each year, spending more than $ 7 billion, according to the Pew Charitable Trusts.
But with new regulations proposed by the Consumer Financial Protection Bureau expected to deeply attack the industry, experts and consumer advocates are trying to figure out what will replace it.
This is how the traditional payday loan model works. A customer will borrow money, often from a payday loan store, where the borrower provides a post-dated check or gives the lender written permission to debit their checking account on a certain date, usually 14 to 30 days from the date. the date of the loan. has been removed. Unlike an installment loan, where the loan is repaid over a period of several months, a payday loan is due in full when it falls due.
The problem with this structure is that the majority of payday loans are renewed or extended, according to reviews, meaning that a customer cannot find the full sum to pay off the loans and has to re-borrow the loan for a fee. About 60% of all loans are renewed at least once, and 22% of all loans are renewed at least seven times, according to a 2014 CFPB study. In California, the largest payday loan market, regular borrowers accounted for 83% of loan volume last year, according to a study by a state regulator released Wednesday.
The CFPB proposal is not expected to go into effect until early next year, and experts don’t think it will change significantly from its current version. It would require payday lenders to determine each customer’s ability to repay that loan within the allotted time and limit the number of times a customer could renew the loan. The CFPB proposal poses an existential threat to the payday lending industry in its current state, according to industry officials and regulators, with loan issuance set to drop from 59% to 80%. While most of this decline, according to the CFPB, would come from the cap on renewed loans, the CFPB recognizes in its proposal that the volume of payday loans would decline under the new regulations.
“Frankly, there will be fewer small dollar loans available to consumers as a result of this proposal. There will be no individual replacement. And anything that replaces it will be a substandard product, ”said Bob DeYoung, professor of financial markets at the University of Kansas.
The industry has historically moved quickly from product to product to evade regulation. When Arizona voters banned traditional payday loans in 2010, payday loan storefronts quickly turned into auto title lending stores – offering the same high interest loans structured differently. Other payday lenders have moved to Indian reservations to evade state regulations or are moving to countries other than the United States as online-only payday lenders.
But these regulations, the first nationwide crackdown on payday loans, would shut down thousands of payday loan stores across the country.
“This proposal does not modify or reform an existing product. This is a complete overhaul of the industry, ”said Jamie Fuller, senior vice president of public affairs at Advance America, a payday lending chain.
What would replace payday loans is not an easy question to answer, but there are a few scenarios that industry experts and consumer advocates expect to happen.
SAME BIRD, NEW FEATHERS: The simplest answer is that the industry will survive and continue to do what it does by changing the nature of the loans it gives.
Nick Bourke, a researcher at Pew who has spent more than five years studying the payday lending industry, says the industry is already making adjustments as a result of the new regulations. When Colorado effectively banned traditional payday loans, the industry shifted to high-cost installment loans that are paid off in months instead of being prepaid in weeks.
“There will be fewer two-week payday loans due to CFPB rules, but the industry has already moved to an installment loan which is paid over several months. There will always be high interest payday loans in the market, ”Bourke said.
GUARANTEE: Another possible beneficiary can be the pawn shops. A 2015 Cornell University study found that states that banned payday loans saw more activity in pawn shops and more chequing accounts were closed unintentionally, a possibility due to an increased number of people doing so. an over-counting of their accounts. But pawn shops are widely regarded as a place of borrowing for people who don’t have a checking account.
BANKS TAKE OVER: Consumer advocates and the CFPB have publicly stated that the best solution would be for traditional banks, which are highly regulated, to take over payday loans. Banks have many locations, easy access to funds, and can provide loans at much lower interest rates while still being profitable. But the banks were cold at best. Payday loans are considered risky and expensive. The underwriting and processing costs would eat into the benefits of the high interest rates they carry.
“Most of our members are willing to take small dollar loans, but they are not very profitable. The application fee does not cover the cost of applying, processing and checking credit. There are only fixed costs that you just can’t get around, ”said Joe Gormley, assistant vice president and legal counsel for the Independent Community Bankers of America, a lobby group for small banks.
CREDIT COOPERATIVES: There are already experimental alternatives to replace payday loans.
A program run by credit unions is called the Alternative Payday Loan, where a customer can borrow between $ 200 and $ 1,000 at an interest rate of 28% and an application fee of $ 20. But interest in the program has been limited. The federal regulator of the PAL program estimates that only 20% of credit unions have provided such loans and that loan origination was only $ 123.3 million last year, down from some $ 7 billion. dollars that the payday lending industry made in the same year.
There is also a pilot program in Atlanta, run by the Equifax credit agency and the National Federation of Community Development Credit Unions, which will offer payday loan alternatives with lower interest rates as well. as financial advice to help people avoid borrowing in an emergency again.