The Consumer Financial Protection Bureau took an important step toward ending payday lenders' predatory practices in March by releasing a proposed framework for regulating the industry. But the CFPB and director Richard Cordray have yet to take the next critical step: actually issuing regulations on the payday lending industry. With each day that passes without new rules, more Americans are falling prey to loans that may trap them in a cycle of debt. The CFPB should take action — and soon.
There's no denying the strong demand for payday loans in the American economy. More than half the nation's consumers (56%) have subprime credit scores, according to research from the Corporation for Enterprise Development, meaning they cannot qualify for affordable and safe credit. These consumers are more likely to resort to high-cost alternative services, such as payday loans, to meet every day financial needs. The CFED research found that one in five households relies on these alternative financial services.
Many of the people most vulnerable to payday and other predatory loans are low-income families, households of color and seniors on fixed incomes — people who already occupy a fragile position in the American economy. Payday lenders know the statistics favor their industry, which is why they aggressively market their product to those without access to affordable credit.
For households struggling to meet basic needs, a payday loan can seem like an attractive way to stay afloat until the next pay check. Unfortunately, research from the Pew Charitable Trusts found these loans are not as small or short-term as consumers anticipate. In a year-long period, the average payday loan borrower is indebted for five months, spending a total of $895 for what was initially a $375 loan.
What's more, Pew found that just 14% of payday borrowers were able to pay off the full loan within the standard two-week period. The CFPB's own research found that nearly half of payday borrowers take out 10 or more loans per year, paying fees on each loan rollover and new loan.
The CFPB's proposed framework would do much to rein in the industry's most abusive practices. It would prevent lenders rolling over the same loan multiple times, a practice all too common in an industry where interest rates average just under 400% APR. The framework also prevents mandatory check-holding, a practice in which lenders require the borrower to provide a post-dated check or written permission to automatically withdraw money from their bank account — regardless of whether they have the funds to cover it.
These reforms need to be implemented as soon as possible. With each day that passes, more and more low-income consumers will be stripped of their hard-earned cash and trapped in a cycle of debt and poverty. Consumers cannot continue waiting around for rules that would protect them from these predators, who meanwhile reap $46 billion in profits annually off the misfortune of struggling families.
Federal regulations would also help level the playing field for consumers who live in states with few, if any, controls over payday lending. Missouri, for example, allows lenders to charge interest rates of more than 1,900%. The District of Columbia and 17 states have regulations in place to protect consumers from payday loans, but most states lack the protections that consumers need and deserve.
But before the CFPB issues new regulations, it should incorporate a few additional changes. For one thing, it should explicitly address the problem of unscrupulous online lenders who violate state consumer protection laws by strengthening states' capacity to protect their citizens from predatory loans made online.
The CFPB also should go further to ensure that payday lenders determine a borrower's ability to repay loans. In the current proposal, the CFPB outlines two methods to protect short-term loan borrowers from falling into a cycle of long-term debt, allowing lenders to choose the method they prefer.
Unfortunately, only one of these methods requires lenders to underwrite for the ability to repay. The other allows lenders to skip the underwriting if they provide affordable repayment options that limit refinancing, re-borrowing and other risky features such as balloon payments.
It is standard practice in nearly all other forms of lending to determine a borrower's ability to repay. The same should hold true for small-dollar lending.
Many in the payday lending industry contend that federal regulations are unnecessary. But given the industry's track record, the need for such regulation is clear. It's time the CFPB took the strong steps needed to significantly change this country's approach to small-dollar lending and protect consumers from an industry that strips wealth from families and impinges economic mobility.
Andrea Levere is president of the Corporation for Enterprise Development.