Payday Loans Prey on the Vulnerable
Financially-strapped individuals turn to payday loans when they need cash between paychecks and have exhausted every other option. These borrowers are rarely eligible for other kinds of credit, and don’t want to borrow from family and friends.
Each year, about 12 million borrowers take out payday loans. The U.S. Consumer Financial Protection Bureau calls payday loans “debt traps.” Research shows that they often push low-income borrowers off the financial cliff, into bankruptcy or default.
Only about 14 percent of borrowers are able to repay payday loans on time. The average borrower, by comparison, carries a debt for five months. During this time, the loan adds new fees. By the fifth month, a person who borrowed $375 will have paid an additional $520 in interest, on top of the amount borrowed.
What Is a Payday Loan?
A payday loan is a relatively small but very high-cost loan, typically due in two weeks. It is made with a borrower’s post-dated check or access to the borrower’s bank account as collateral.
Payday loans are known by many names, including cash advance loans, check advance loans, post-dated check loans or deferred deposit loans. Many people seek payday loans from storefront check cashing operations. Increasingly, however, people seek them from banks or even online.
Storefront Payday Lenders
Payday lending is regulated by the states. Payday loans first appeared as storefront products about 20 years ago. They are illegal as “predatory” in 15 states and the District of Columbia. Nine other states allow payday lending with restrictions, such as limits on loan amounts, interest rates, loan terms and the number of loans a person may take out. In the remaining states, payday loans are largely unregulated.
Major Banks See Opportunity
Now that the CFPB has restricted the fees banks may charge on debit and credit cards, some large banks are trying to make up for these losses by offering payday loans — a product that they call deposit advances. The bank advances the money and repays itself (plus fees) when an electronic deposit — a paycheck, or a Social Security or disability payment — is made into the borrower’s account.
The Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency in 2013 proposed new guidelines for banks offering deposit advances.
Under the proposed guidelines, banks will be required to assess the consumer’s ability to repay before making a loan. They must wait 30 days before making another loan, and cannot extend loans to borrowers who have not paid off their previous obligations. Finally, they will be required to disclose to borrowers the actual costs of the loans.
Payday Loans on the Internet
Nearly 40 percent of payday loans as of 2012 are made online. By 2016, this number is predicted to be 60 percent. To bypass state restrictions and caps on interest rates, lenders have set up online operations in unregulated states or offshore locations like Belize, Malta and the West Indies. Native American tribes have also used their sovereign status to avoid state laws and set up online payroll lending operations.
After making a payday loan, these lenders use “automatic withdrawal” privileges at the borrower’s bank (even in states where payday lending is banned or restricted) to retrieve their payments. The bank then collects overdraft fees. Under federal law, borrowers should be able to revoke the lender’s automatic withdrawal privileges or close the account, but many have found it difficult to do so.
The proposed “Safe Lending Act” would require that online lenders comply with state laws.