Critics of the Consumer Financial Protection Bureau's proposals to rein in payday loans argue that onerous requirements could force many lenders to shut down, leaving cash-strapped Americans with few options for short-term credit. But the truth is payday loans often leave low-income borrowers in even worse straits.
Through my work with the nonprofit advocacy group Reinvestment Partners, I see the difficulties facing lower-income consumers firsthand. Our agency provides free tax preparation services and pre-purchase homeownership counseling and negotiates loan modifications on borrowers' behalf. I can say with conviction that our work is informed by what is happening "on the ground."
One benefit of this is that we develop long-term relationships with lower-income people who are rarely "economically mobile." The tax refunds that we can facilitate have usually been exhausted by the same time next year. Many people are struggling to find sufficient work. When formerly dislocated workers do find employment, it is too often the case that they never enjoy the same level of compensation. They move from a salary of $60,000 to a far less secure job that pays $15 per hour.
Our clients have long-term financial challenges. They were living paycheck to paycheck six months ago, they are living paycheck to paycheck now, and most likely, they will be in a similar situation well into the future.
Our experiences contradict these stories. A payday loan will not right the ship for cash-strapped people. In fact, it might be the decision that sinks them.
An extra $350 might take the edge off for a few days. But the costly interest and fees that come with the loan will only make things that much worse. Proponents of payday loans often claim that they help people through a rough patch, allow them to smooth out the peaks and valleys of their volatile incomes and even help families stave off eviction. This might be true in some instances. But if that's the usual situation, why are there so many rollovers and defaults?
That's why I approve of the CFPB's initial concepts for the regulation of payday lending. The agency's approach would hold lenders accountable at the moment of underwriting, during the repayment period, and even in subsequent debt collection efforts.
While payday lenders may be forced to adjust their business models, well-meaning ones should be able to operate in this new framework. Lenders say that they already vet for "ability to repay." If that's the case, the CFPB's requirements shouldn't be a major added burden.
Sometimes lenders repeatedly tap a borrower's account even after the charges are being returned unpaid, a practice that creates a subsequent waterfall of overdraft fees. The CFPB is also asking lenders to get reauthorization from borrowers after two failed attempts at collection. A responsible lender would not want to trigger numerous nonsufficient-funds fees for their customers.
In addition, insisting that lenders offer a repayment plan is hardly an overreach. Mark Twain once said, "I'm not as concerned with the return on my money as I am the return of my money." To that point, having to offer a repayment plan is a sensible way of keeping lenders whole while simultaneously helping consumers to avoid a debt trap.
This is not a rule that eliminates short-term lending, but instead one that makes credit accessible in a safe fashion.
Toward the end of the CFPB's field hearing on payday lending in Richmond, Va., a man from Richmond said a few words that summed up the theme of the day. He pointed out that while money can be a fine thing, where there is money, there is always someone willing to be unscrupulous to get more of it. This may not be the case for the lenders who are here today, the man went on to say, but clearly there are such people out there. Preventing them from taking advantage of others is the role of the government.
I still have concerns with how the political process will influence the final rule. The CFPB's proposed rules could be watered down by the efforts of industry lobbyists. And it would be a shame if a national rule was then used to justify efforts to restore payday lending in states where it is currently illegal.
Moreover, the CFPB's rule-writing staff needs to close a few loopholes. The proposal currently includes two different approaches: prevention, in which lenders are steered away from making loans that borrowers won't be able to pay back, and protection, in which lenders are required to ensure that borrowers have an affordable way to pay back their loans. But borrowers don't need a choice between prevention and protection -- they need both. In addition, there is a very real possibility that the principle of ability-to-repay could be undermined in instances where lenders are allowed to focus only on income in underwriting of some installment loans. That should be changed.
Finding a rule that accommodates groups with very different viewpoints is inherently difficult, but in our opinion, this is what the CFPB has done. Ultimately, the rules will give consumers access to credit but in a much safer framework. That is a good outcome for everyone with a stake in this conversation.
Adam Rust is the research director at Reinvestment Partners. Follow him on Twitter @bank_talk.