The cycle of the payday loan is a well-known horror story. A person needs money, and they need it fast, so they visit a payday lender with names like EZ Cash or Cash Express. They get their money on the spot. The trouble comes later, when it’s time to repay the loan. Most borrowers default on that small-dollar loan, which is how EZ Cash profits—as the loan is renewed or rolled over and the fees rack up.
One of the last regulations published under President Obama’s director of the Consumer Financial Protection Bureau (CFPB), Richard Cordray, was a 2017 rule that would have curbed the most-egregious forms of payday lending. The Trump administration on Wednesday proposed to revise that rule—aiming to gut a powerful provision designed to protect borrowers.
The oft-cited statistic that the average American doesn’t have the means to come up with $400 in an emergency was thrown into sharp relief over the past month, as federal workers missed out on their paychecks during the longest government shutdown in history. Workers told of difficulties buying diapers for their kids, trying their hands at Uber driving, and visiting food banks for the first time.
Some workers undoubtedly turned to payday lenders.
That can be a devastating turn. What with roll-overs and fees, the average payday loan comes complete with a 391 percent annual percentage rate (APR). Lenders will do whatever it takes to get that growing pile of money, often debiting funds directly out of their customers’ bank accounts.
It’s not an experience that most federal workers likely have dealt with—most are at least middle-income, though many federal contractors are paid less. (Also, unlike the federal employees, the contractors are not receiving back pay.) Payday lenders typically target low-income people, and the most marginalized at that. Their storefronts are more likelyto be found in poor neighborhoods and communities of color (where, conversely, banks are less likely to be found).
But as the shutdown taught us, even many middle-income folks can’t manage if they miss one paycheck. According to the Financial Times, shares in some short-term lending companies rose during the shutdown, and “the rises are much more than benchmarks, suggesting investors could be betting on a surge in demand to cover unexpected expenses.”
In October 2017, the CFPB finally issued its rule, which would curb the more extractive parts of the industry. Lenders would need to factor in a client’s “ability to pay” when putting forth terms; they could not charge interest of more than 6 percent of a person’s income—a rule which would only go into effect after the person’s sixth loan. It also would limit lenders’ ability to repeatedly debit borrowers’ bank accounts directly.
Not surprisingly, the industry voiced its displeasure (with some industry groups filing a lawsuit). Also not surprisingly, the Trump administration’s CFPB, with most of its teeth pulled by then-Acting Director Mick Mulvaney, announced in October 2018 that it would be revisiting the rule, focusing on that ability to pay provision.
One month later, a federal judge stayed the effective compliance date of the rule—when the CFPB would begin enforcing it—which was meant to be August 2019. The compliance date is now stayed until a further court order, since the bureau had announced it would be revising the rule. (Before Mulvaney announced the planned revision, the same federal judge had twice refused to stay the compliance date.)
Under the new proposal released by the Trump administration, the CFPB’s recommended compliance date is now November 2020. (The bureau is now supervised by Director Kathy Kraninger, who was confirmed in December of last year.) But the main provision on the chopping block under the new proposal, scaling loans to borrowers’ ability to pay, is the very heart of the rule’s intended protections, according to Scott Astrada at the Center for Responsible Lending (CRL).
“The rule, as it’s written, requires a common-sense verification process to ensure that the borrowers have the ability to repay [the loan],” Astrada says. As of now, many lenders do not require any information about a borrower’s financial situation—no verification of employment, no bank records, and so forth. The rule that was announced in 2017 would require some of this basic documentation, meant to combat the payday lending industry’s “fee-based, extracting structure,” according to Astrada, meant to squeeze out as much money as possible from people who typically cannot pay their loans back. The new proposal to rescind this provision is open for public comment for 90 days before a final version will be published.
Before the 2017 rule was enacted, payday loans—often called predatory loans by their critics—had been the subject of contentious debate for years. Consumer advocates have argued that because 80 percent of loans are renewed or are rolled over within two weeks, people find themselves unable to pay their loans back even as the interest they owe continues to mount. According to a 2012 Pew survey, 5.5 percent of Americans had taken out a payday loan during the previous five years. It’s this kind of research that informed the 2017 rule in the first place.
The trouble is that this issue is not so black and white—though the gray area is very small. Consumer advocates rightly point to research on borrowers’ cycle of debt—but the industry does have somewhat of a point. While it is true that payday lending is an exploitative model, and that people often find themselves paying much more in interest than the amount of their loan, it is also true that many low-income people do sometimes need cash immediately. Many people who have taken out payday loans regret it. But crucially, some don’t.
In her book The Unbanking of America, Lisa Servon, who took jobs at check cashers and payday lenders for her research, writes of a woman, Ariane, who took out five payday loans when her car broke down and struggled to pay them back. Servon asked if Ariane thought payday lending should be illegal. Ariane said, “No, I think they should still exist. You know it’s undoable to take out five loans and pay them back. But sometimes you have no choice.”
Yet Ariane’s experience of needing loans to pay for an emergency, which the industry would say is the prototypical experience with loans, is not really the norm. Most people who take out payday loans actually use them to pay for basic necessities—for groceries or the electric bill. According to the Pew survey, 69 percent of first-time borrowers used their payday loan for a regular, recurring expense. Just 16 percent reported using their loan for an emergency.
Astrada says the payday lending rule as enacted wouldn’t have totally killed the small-dollar loan industry—it would have just targeted the “worst of the worst” (one reason why some consumer advocates didn’t think the rule went far enough). However, the most exploitative lenders are a good chunk of the industry—more than 90 percent of the loans now made would be targeted by the rule, according to the industry itself. The majority of the industry’s profit comes from borrowers who default over and over, and get trapped in the very cycle of debt that Astrada describes.
But while it may not be enough to simply abolish payday lending, there are few progressive policy ideas that would address the problem low-income people face when they need money immediately. Some federal employees, being middle-income, likely had networks—friends and family—who could front them rent money until they got their back pay. For low-income people, these kinds of networks are less prevalent.
Astrada says that one popular alternative to payday loans are payday alternative loans—commonly called PALs. PALs are issued by credit unions and cap annual interest rates at 28 percent. They gauge a borrower’s ability to pay, and application fees cannot exceed $20. Yet only one in seven credit unions even offer such loans.
Banks don’t regularly offer such loans at all. Some of the big American banks offered small-dollar loans during the government shutdown for furloughed employees, but that generosity does not extend to the low-income population who regularly need small loans—they are, after all, not the banks’ desired customers. To fill this lending void, one fairly popular idea is to revolutionize the brick-and-mortar post office system so it can also provide financial services like banking and low-interest small-dollar loans. Democratic Senator Kirsten Gillibrand of New York sponsored legislation to that end last year.
Some advocates also hope that if the payday lending industry’s predatory practices are curbed, banks will join the small-dollar lending market. In September, U.S. Bank did just that, launching a first-of-its-kind small loan program “with no hidden fees.” U.S. Bank customers can borrow between $100 and $1,000, and the annual percentage rate (APR) of these loans are between 71 percent and 88 percent—still pricy, but much lower than the typical payday loan’s APR of nearly 400 percent.
But not all consumer advocates praise bank programs like this one. "This type of product isn’t a safe alternative to a payday loan, and we reject the notion that bank loans as high as 70 to 88% APR will drive out higher-priced credit by non-banks,” Rebecca Borné, Senior Policy Counsel at CRL, said in a statement. CRL, like many advocacy groups, recommends a 36 percent APR cap on loans (a standard which many states have adopted—through such laws, 16 states and the District of Columbia have effectively outlawed payday lending).
So there aren’t any surefire alternatives for people needing to access emergency cash. That’s not because the answer is elusive, but rather because we’re asking the wrong question. The question shouldn’t be, What is the alternative to getting people emergency loans? Rather, it’s, How do we ensure that people can survive without having to rely on loans?
In which case, there are clear alternatives to payday lending: a living wage, stronger unions, and robust public assistance programs.
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This article has been updated.