Why you should care
Most payday borrowers end up paying more in fees than their loan is worth. Policy is fighting back.
Pooja Bhatia is an OZY editor and writer. She has written for The Wall Street Journal, The New York Times and the Economist, and was once the mango-eating champion of Port-au-Prince.
Money doesn’t come cheap at the payday lender, and these outfits loan an astounding amount — almost $20 billion annually, according to the Center for Responsible Lending. Not bad for an industry that started in the early 1990s with just a few hundred storefronts. Now there are more than 16,000, according to the CRL. For this we can thank widespread financial deregulation on the federal level in the 1970s and 1980s, and in state legislatures afterward.
In a payday loan, people pay a flat fee to borrow against their next paycheck. As collateral, they hand over a signed check for the loan amount, plus the fee. If they don’t repay their loan and the fee by the next paycheck, the lender cashes the check. They add up: The Pew Charitable Trusts found that short-term loans can chew up 36 percent of the borrower’s paycheck.
…the industry is a predator’s paradise.
Lately, lawmakers have been debating whether to subject payday lenders to more regulation. While lenders say they provide vital bridge financing for people who can’t access emergency credit, the Consumer Financial Protection Bureau argues that the industry is a predator’s paradise, trapping many borrowers in a vicious debt-and-fee circle. Most end up paying more in fees than the loan amount. Four of five payday loans in its sample were “rolled over,” or renewed, within 14 days. The less polite term for this is “churning,” and payday lenders pocket some $3.4 billion a year in what the CRL calls “excessive loans.”
Payday borrowers have jobs, of course. Many have checking or savings accounts, but don’t use formal credit: They’re “underbanked.” About a fifth of the U.S. population is underbanked, according to the last FDIC household survey, conducted in 2011. That’s 24 million households. Some of the underbanked are credit-worthy, but they lack credit scores or have low ones — “thin file” borrowers. They’re trapped in another vicious circle: You can’t get formal loans without a history of repaying them, and you can’t repay a loan you can’t get.
Some in the credit industry and in policy have been trying to unloop that circle. One big idea: Allow the underbanked to use rental and utility payments to build their credit scores, and then let them access formal credit where interest rates are better regulated. But they’ve made little progress. And fee caps? Fifteen states cap fees at an annualized interest rate of 36 percent. But none of these states have payday lenders. On the other hand, says Diane Standeart of the CRL, payday lenders have a “declining footprint” because of unfavorable policy trends. No state has legalized payday since 2005.
This OZY encore was originally published Aug. 7, 2014, and has been updated to reflect recent developments.