Online payday lenders operate a Wild West marketplace full of financial fraud and consumer abuses, according to a new report released by the Pew Charitable Trusts.
The report is a result of the most thorough assessment to date of the online payday loan business and its findings, released Thursday, are scathing. Pew found that online borrowers faced a variety of abuses, ranging from threatening debt collection calls to overdrafts caused by having their accounts tapped by payday lenders. One in five online borrowers said they had lost access to a bank account as a direct result of taking out an online payday loan.
The report comes just two weeks after the Consumer Financial Protection Bureau and Federal Trade Commission penalized a group of online lenders for taking an estimated $150 million from consumers' bank accounts without consent. Those payday lenders used personal information that consumers had provided to online loan-shopping sites to deposit loans in consumers' accounts and then hit them with finance charges.
The online payday loan business is growing, despite the problems described in the study and recent large-scale enforcement actions. About a third of payday loans are made online, and revenue from online loans jumped from $1.4 billion in 2006 to $4.1 billion in 2013.
Pew has released three previous reports about payday lending and is a sharp critic of both online and storefront lenders. The most recent report focuses on ways in which online lenders are different from brick-and-mortar stores.
Among Pew's findings: nine out of 10 Better Business Bureau complaints about payday lenders involve online operators, even though online loans only make up about one-third of the total market; 30% of online borrowers report being threatened by a lender or debt collector; and online payday loans typically have annual percentage rates of 650%.
"It's clear that basically the kind of self-policing of online lenders has not worked," said Alex Horowitz, research manager at Pew.
Pew found that borrowers who dealt with online lenders were put at risk by:
Abusive collection tactics. A third of online borrowers said online lenders or collectors made threats to arrest them or expose their debts to family or employers threats that violate the Fair Debt Collection Practices Act.
Disclosure of personal information to third parties. Nearly 40% of online borrowers reported that sensitive personal information they gave to payday-loan-search sites called lead generators had been sold to a third party without their consent.
Automatic renewals of loans without their consent. One third of borrowers said online lenders set up automatic payments that covered only fees, triggering loan rollovers that generated additional fees.
Unauthorized or aggressive withdrawals. Close to half of online borrowers reported that withdrawals by a payday lender caused them to overdraw an account. Almost a third of online borrowers reported unauthorized withdrawals by a payday lender. Twenty-two percent said that, as a result of payday tactics, they lost access to a bank account. The borrowers said either their banks shut down their accounts or they had to close an account themselves to try to escape unwanted debits.
Higher fees. Overall, online payday and installment loans cost more than storefront loans, and some carried annualized interest rates as high as 700%.
Seventy percent of online payday lenders are not licensed in every state in which they lend, Pew found, and as researchers combed through complaints filed with the BBB, they found the bulk of complaints tracked back to this large group of lightly licensed lenders.
Among the reasons that online payday loans are so expensive include the high cost of acquiring borrowers. The lenders rely heavily on lead generators, which typically have to pay search engine companies from around $5 to $13 every time a consumer clicks on one of their ads, according to the report.
In one state, Vermont, Google, Microsoft and Yahoo have agreed to disable advertising for any lender that is identified as violating the state's strict interest rate cap. Pew officials said they do not have a position on whether search engine companies should bear any responsibility.
The largest lead generator, MoneyMutual, which runs TV ads featuring former talk-show host Montel Williams, spent roughly $211 million on advertising over a 12-month span, the report found.
As a result of all the advertising, customer leads are expensive to buy. Pew found that a lead used to cost as much as $125, though prices have since fallen.
The lead generators collect sensitive information from prospective borrowers, including Social Security numbers and bank account numbers, and then sell it to multiple lenders. The first buyer, which pays the highest price, gets a brief exclusivity period, but soon the consumer may get bombarded with multiple offers.
To make their money back, online lenders need their borrowers to roll over their loans multiple times. Pew found that one in three online borrowers has taken out a loan that was set up so that they would pay only a fee on their next payday, and the entire loan principal would be automatically rolled over. "To pay more, most of these borrowers had to make a request by phone," the report states.
Pew notes that many of the problems it found are violations of a set of best practices developed by the Online Lenders Alliance, a trade group that represents lenders and lead generators.
Lisa McGreevy, the trade group's president, said that the group's member companies strive to implement its best practices, but she would not say whether members have all fully implemented them.
"Self-policing actually does work," McGreevy said, pointing out that a number of Kansas City area-based online lenders that were recently charged with violations of the law are not members of the Online Lenders Alliance. "We have a demonstrated record of changing behavior through our best practices."
The CFPB is expected to issue payday rules by early next year. Pew urged the CFPB to seize the opportunity to ban harmful practices and establish ground rules for fair lending.
McGreevy said the Online Lenders Alliance is prepared for those new rules.
"We not opposed to regulation at all. In fact, you know, we welcome it. These are the lenders of the future. So our people are compliant, they want to play by the rules," she added. "When we find out that there are abuses, or issues that come up in the industry, we have a very robust complaint system."