Every year, despite the risks and high costs, millions of Americans turn to payday loans for emergency funds. To date, a top-down, regulatory approach has been the primary means of addressing the downsides of the payday lending industry. To improve protection of consumers and encourage this industry to mature, such regulation should be joined by efforts that encourage market transparency.
Earlier this year, as the Consumer Financial Protection Bureau began laying its framework for developing regulations around payday lending, its director, Richard Cordray, spoke of "the need for emergency credit," as long as these products "help consumers rather than harm them." Yet regulating this industry is not straightforward, as according to a Federal Reserve study last year, restricting access to payday lending may "deny consumer access to credit, limit their ability to maintain formal credit standing, or force them to seek more costly alternatives."
As regulators work to develop fair lending policies, particularly for underbanked markets, consumers who choose to take out a payday loan must navigate a fairly complex space under less than ideal circumstances. Consumers, often unknowingly, must select from a wide and often uneven range of providers, including tribal-based entities, out-of-state licensed lenders, offshore entities, and state licensed lenders. They often face these decisions under the stress of meeting a short-term, critical financial need with few other options. This is not an ideal situation for making financial decisions, yet millions do every year. According to the FDIC, 17.9% or roughly 21 million households are underbanked and rely on alternative financial services like payday loans.
Regulation can help protect consumers, but simple tools that provide relevant information in one place can help consumers protect themselves. A transparent marketplace levels the playing field, encourages competition, and rewards legitimate players. There is no better place to create these tools than in online payday lending. According to JMP Securities, 36% of short-term lending transactions were done online in 2011. By 2016 it expects this to rise to 68%.
The underbanked are not under-connected, but they are underserved. A search on "best credit card" yields pages of sites fully dedicated to providing rankings and reviews of credit cards. They provide calculators, search tools, and articles on finding credit cards. They rank cards based on price and service. Yet a search on "best payday loans" yields a page of results where the top results are not even dedicated to payday loans. There are no calculators or tools and the results that do show generally promote specific lenders.
This lack of transparency provides cover for unscrupulous companies among legitimate lenders. Providing information on lender specifics and available alternatives enables consumers to make more informed decisions about their finances.
Simple tools such as payday loan rankings, like those provided by my company, that highlight lender prices, legal structures, Better Business Bureau rankings and privacy policies help customers navigate the differences among lenders.
Loan option analyses that explain when a payday loan is cheaper than other options, such as bank overdraft fees, further help consumers to make intelligent choices. And finally, reviewing new entrants into the space, like Wells Fargo’s Direct Deposit Advance product, keeps consumers abreast of new options. Market transparency leads to informed consumer choice, helping consumers, rewarding sound business practices and discouraging dishonest behavior.
Our preliminary data supports this premise. When payday lenders are ranked and reviewed, the highest scoring lenders receive almost five times as many visits to their loan applications than do the lowest rated lenders, making a strong case for transparency rewarding good behavior.
As regulators work to improve the payday lending industry, the underbanked can benefit from simple online rating tools to help them as well. The underbanked should not also be underserved. It’s time for some market transparency.
Con Way Ling is a co-founder of The Payday Hound, which aims to provide impartial reviews of every online payday lender.