Lenders who advance poor people money on their paychecks charge exorbitant interest that often snare the most vulnerable customers in a cycle of debt, the industry’s critics have long said.
Yet even consumer advocates who loathe the industry admit it fulfills a need: Providing small amounts of cash quickly to people who can’t qualify for credit cards or a bank loan. Roughly 12 million Americans take out a payday loan each year, spending more than $7 billion, according to the Pew Charitable Trusts.
But with proposed new regulations from the Consumer Financial Protection Bureau predicted to cut deeply into the industry, experts and consumer advocates are trying to figure out what will replace it.
The traditional payday loan model works like this. A customer will borrow money, often at a retail payday loan store, where the borrower provides a post-dated check or gives written authorization for the lender to debit their checking account on a certain date, usually 14-30 days from the date the loan was taken out. Unlike an installment loan, where the loan is paid back over a period of months, a payday loan comes due in its entirety.
The problem with this structure is that the majority of payday loans are renewed or extended, critics say, which means a customer cannot come up with the full sum to pay off the loans and must re-borrow for a fee. Roughly 60 percent of all loans are renewed at least once, and 22 percent are renewed at least seven times, according to a 2014 study by the CFPB.
The CFPB’s proposal would require payday lenders to determine each customer’s ability to repay in the time allotted and would limit the amount of times a customer could renew. The CFPB’s proposal represents an existential threat to the payday lending industry as it stands, industry officials and regulators say, with loan originations projected to drop 59-80 percent. While most of that drop the CFPB says would stem from the cap on loans being renewed, the CFPB acknowledges in its proposal the volume of payday lending would decrease under the new regulations.
“There will be fewer small dollar loans available to consumers because of this proposal. There will not be a one-to-one replacement. And anything that does replace it will be an inferior product,” said Bob DeYoung, a professor of financial markets at the University of Kansas.
What would replace payday lending is a tough question, but industry experts and consumer advocates have floated a few possible scenarios.
■ The simplest answer is the industry will survive, and keep doing what it is doing by changing the nature of its loans.
Nick Bourke, a researcher at Pew who has spent more than five years looking at the payday lending industry, says it is already making adjustments in the wake of new regulations. When Colorado effectively banned traditional payday lending, the industry moved into high cost installment loans that are paid over a few months instead of all upfront in a few weeks.
“There will be fewer two-week payday loans because of the CFPB rules, but the industry has already shifted to installment lending that is paid over several months. There will still be high interest rate payday loans on the market,” Bourke said.
■ Another possible beneficiary may be pawnshops. A 2015 Cornell University study found that states that banned payday loans saw more activity at pawn shops and more checking accounts being closed involuntarily, possibly due to an increased amount of overdrafts. But pawn shops are largely seen as a place for people to borrow who don’t have checking accounts.
■ Consumer advocates and the CFPB have been quite public in saying the best solution would be for traditional banks, which are highly regulated, to take over payday lending. But banks have been cool at best to the idea.
“Most of our members are willing to do small dollar loans, but they are not very profitable. Application fees don’t cover the cost of doing the application and the processing and the credit check. There are just fixed costs that you just cannot get around,” said Joe Gormley, assistant vice president and regulatory council at the Independent Community Bankers Association, a lobby group for small banks.
■ There are already some experimental alternatives going on to replace payday loans.
One program run through credit unions is called the Payday Alternative Loan, where a customer can borrow $200 to $1,000 at 28 percent interest and an application fee of $20. But interest in the program has been limited. The federal regulator for the PAL program estimates only 20 percent of credit unions provided such loans, and loan originations were only $123.3 million last year, a drop in the bucket compared to the roughly $7 billion the mainstream payday lending industry did in the same year.
There’s also a program being tried in Atlanta, run by the credit agency Equifax and the National Federation of Community Development Credit Unions, that will provide payday loan alternatives that would come with lower interest rates as well as financial counseling.
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