In response to a recent op-ed on this blog defending payday loans, Rep. Linda Sánchez, D-Calif., countered that payday lenders create "debt traps" by forcing borrowers to take out additional loans to repay escalating interest on their original loan. I agree that this is a terrible cycle of debt for those who can least afford it.
However, Sanchez is inaccurate and misinformed when she lumps the traditional installment loan industry together with the payday loan industry. There are significant differences.
This mischaracterization is the result of advocates for the payday loan industry attempting to blur the clear lines of distinction between traditional installment loans, which make affordable credit accessible to millions of Americans, and predatory, cycle-of-debt loans like payday.
It is essential that our lawmakers are able to understand the differences between traditional installment lending and payday loans that are hurting hardworking families every day.
The traditional installment loan industry is more than 100 years old and provides access to credit for consumers to pay for necessary and often unexpected expenses. Installment loans have payments and terms based on the borrower's ability to repay. For example, traditional installment loans, such as those made by member companies of the American Financial Services Association, are structured with built-in consumer protections and safeguards against default.
For example, a borrower's ability to repay a loan is worked out in advance and regular, equal-sized payments are scheduled, giving the borrower agreed-upon affordable monthly payments and a clear pathway out of debt.
Also, unlike payday lenders, installment lenders report loan performance to credit bureaus, giving borrowers the opportunity to build credit, which eventually could lead to better terms on future loans as the result of a better credit score. This type of due diligence for the benefit of both the borrower and the lender is totally disregarded with a payday loan.
Payday lenders do not properly test the borrower's ability to repay the loan, and require loans to be repaid in one lump sum, usually within 30 days, pegged to a paycheck. It is this "balloon payment" that can cause a cycle of debt in which borrowers are forced to constantly refinance loans with new fees when they cannot pay back the original loan.
But in contrast, traditional installment lenders have built a business based on trust with their customers. Installment lenders live and work in the communities they serve and are involved on a daily basis in building strong and resilient communities across the United States.
They are a key fixture in the U.S. financial services industry. It is critical that lawmakers such as Sanchez and regulatory agencies like the Consumer Financial Protection Bureau know the difference.
Bill Himpler is executive vice president for the American Financial Services Association in Washington, D.C.