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What Can The CFPB Do To Regulate Payday Lenders?

posted by Nathalie Martin

Even though the CFPB cannot cap interest rates on payday loans, there is still plenty that the CFPB can do to regulate these lenders. But what should the Bureau do? Some of the trickiest aspects of the payday lending issue have nothing to do with interest rates, and everything to do with how the loans are marketed and used.

Even the staunchest consumer advocate would likely look favorably upon a loan product that allowed people who could not otherwise get credit to borrow money for occasional, unexpected, emergency expenses. I suspect that most would agree that this would be a good and useful loan product even if it cost $15 or $20 for every $100 borrowed, as long as the product were used only occasionally to smooth consumption. This would be true even if the annual interest rate was over 500%. In a way, the annual percentage rate interest would not matter much because the loans would be truly short term, both in design and marketing, as well as actual use. 

In reality, these loans are rarely short –term or occasional. Empirical data show that the loans are often used habitually. The average loan is rolled over numerous times, and many consumers pay on the same loan for years at a time. Moreover, the loans are most frequently used to pay regular, recurring bills like rent and utilities, not for emergencies. This means that once one has borrowed the money, if the person cannot pay it back with the fee, he or she now has another monthly or bimonthly bill to pay. 

Perhaps not surprisingly, it is hard for a lender to make a profit off occasional, emergency-facing customers. Thus, lenders’ marketing encourages customers to use the loans for many non-emergency purposes. Advertisements suggest that the loans are a perfect way to fund vacations, Christmas and birthday presents, and even the bachelor party blogged about earlier. Lenders do anything to keep borrowers in loans. In other words, while lenders claim that they are here to help when travesty hits, and that their customers would be harmed if they faced an emergency, many of the loans are used for discretionary purposes, at the lender’s urging, and at a cost that customers do not understand.

With these realties as a backdrop, I suggest these as possible areas of regulation for payday loans. In order to make sure these laws are followed by an industry very savvy at getting around whatever laws are passed, any violation should result in an inability to enforce the loan, period:

1. A National database for all loans (and if it's not there it is not enforceable).
2. A strict limit on rollovers and total loans per year per customers.
3. Disclosures that consumers can read and understand (not typical TILA garbage), given in the store, in huge print on the documents, and pointed out and repeated orally by the clerk.  These should be written or vetted by someone who teaches school at the level of the average reader in America.
4. No enforcement of mandatory arbitration clauses.
5. No enforcement of mandatory class action waivers.
6. Rules against certain kinds of advertising.

There is far more urgency in dealing with this issue than many people realize, especially for internet payday loans. A huge segment of the payday loan market is reportedly shifting to internet loans, where there is no regulation at all. The wish list above does not address the issues unique to internet lenders but hopefully future blog will.

 

 

Comments

I am one staunch consumer advocate who is not sure I would likely look favorably on such a scheme. If you make -- and successfully enforce -- rules tight enough to control the abuses, no one will bother with this benighted business. If one is determined to try going down that road, however, I would suggest a simpler model: a solid all-fees-included usury limit, with an exception: a larger loan premium fee permitted once or twice per year per customer by any given lender, to cover a "true emergency" loan. Enforcement, of course, would still be problematical.

I may or may not agree with that approach, but either way, the CFPB can't cap rates. But Ken, you raise one very important thing I meant to say. Enforcement is everything. You can pass all the laws you want, but if no one enforces them, what is the point? That is why I'd like to see some rules that, if broken, make the loan unenforceable.

Ms. Martin, unfortunately, the complexity and cost of such things would preclude enactment.

The simple answer is for each state to enact and ruthlessly enforce simple criminal usury laws, i.e., if the total amounts paid by a borrower (including fees) to any one lender exceed the amount loaned by more than 33%, it's a crime to extend/renew that loan or make another loan to that borrower.

If the loan shark wants to keep a fish on the hook, they have to stay under the simple 33% total threshold; if they think it's just a one-time opportunity, they can go over it but don't get another shot at that victim.

And when the predatory lenders cry about leaving the state, just waive a hearty "good-bye and good-riddance."

Excuse me, but the triple digit interest rates these loans carry is NEVER justified. The rates are conficatory and exploitative, and I cannot condone them under any circumstances. Emergencies do not justify the exploitation of poor borrowers by hitting them with triple digit interest rates. That's the problem with these lenders; they exploit people when they're desperate.

I do not approve of merely regulating the number of rollovers. Besides the interest rate, one of the problems with these loans that keeps people hooked is the balloon payments. Limiting the rollovers only means that the borrower is hit with the balloon payment sooner than later. Force the lenders to give payment schedules that amortize the loans over a reasonable period, say six months to a year at a reasonable interest rate, like the 33% with equal payments. If people are given a reasonable payment schedule and a nonusurious interest rate, they won't default and the loans won't be exploitative. If the lenders can't make money with charging a commercially reasonable interest rate, then perhaps they do not have a commercially reasonable product and should NOT be in business.

I agree with the commenters that usury laws would be the most effective method - and imo theonly really effective method - of implementing one's objections to payday loans. Because ultimately the only really substantive objection is the way the cost runs up. Any other objection is just ancillary to that one. So why not tackle that one head on?

I don't believe that disclosure-oriented laws have any meaningful effect on consumer borrowing.
And certainly not if the payday loan is the only alternative.

I doubt the CFPB has the power to block rollovers. Among other things, what's the alternative to rolling it over? Perhaps you mean impose a price regulation on the rollover, but your comments say you don't think they have rate capping power.

I never thought the CFPB was a good idea, however sincere its proponents may be. I think it will be one more well-intended disclosure-focused law that will eventually prove ineffective like all the rest, after putting another dent in the fisc and adding to the bureaucratic ranks.


I would suggest a strict limit on the number of loans per bank account per year. 1 per quarter.
This would do a great deal to deter the debt cycle caused by using one loan to pay off another.

Ms. Martin has touched on a very important point in this debate about short term credit and that is the need to allow the loan providers sufficient profit on the loan product.

I see people throwing APR caps out without understanding the economics of interest accrual on small dollar amounts. If you can't generate enough interest on a loan to cover the costs, the loan will not be available (at least not legally).

The use of APR as a benchmark for what a small dollar should cost is stealth politics. It has nothing to do with actual costs of the loan to the borrower and his need. Both Jennifer Tescher at CFSI and the Urban Institute pointed out the problems in benchmarking small loans with APR.

By the way, Loan Sharks (illegal, back-street lenders) charge 25% per week on what’s borrowed. Saying a 36% APR is a Loan Shark rate is either foolish or naive. It makes a good sound bite though.

The reason payday loans have exploded over the past 15 years is because of arbitrary interest rate caps on traditional installment loan lenders that prevented them from serving this market. And that’s what they were created for over 100 years ago. At that time it was determined that 3% a month, or 36% APR was necessary in order for legal lenders to make a profit.

There is no reason that small dollar, short term credit cannot be offered on a traditional installment loan which is fully amortizing. This type of loan is what can be referred to as "conscious debt" because it is purpose is tied to term payout. There is clearly too much "unconscious debt" that causes most of the financial stress problems, even when it has significantly lower APRs.

Clearly consumer debt should not have characteristics that cause a debt to be "un-payable" such as an unrealistic balloon payment or payments they can't afford from the beginning. So there are those things that can be done within a regulatory framework to address the structural abuses that truely harm consumers.

But those who advocate APR caps will end up hurting those who they seek to protect more than they know. Artifical price controls always lead to shortages, black-markets, and consumer distress.

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