The payday loan racket may have just gotten more difficult for lenders, but it's still treacherous for consumers.
Last week the Consumer Financial Protection Bureau announced a new series of protections for borrowers who use these services. Financial experts and consumer advocates have criticized the payday loan industry heavily for predatory practices that trap borrowers in cycles of debt. According to the CFPB, the new rules are intended to break that pattern.
Payday loans are generally for relatively small amounts, typically several hundred dollars at a time, and are due by the borrower's next paycheck. In essence, they act as a third party advance; however, at interest rates that dwarf almost any other form of lending. A typical payday loan can charge an APR of 300 to 400%.
Cash-strapped consumers often struggle to make those payments, and as a result, have to take out a new loan at the end of the month to afford both necessities and service on the loan. According to research from the Pew Charitable Trusts, although the average borrower takes out $375 they can only afford to pay $50. So they take a new loan out, and another after that to avoid defaulting on either the debt or bills elsewhere, so much so that the same research indicated that more than 80% of cases a payday borrower takes out another one within 14 days.
Approximately one-quarter of all loans are rolled over in this fashion at least nine times, with the borrower ultimately paying more in interest than they borrowed in the first place.
It's for this reason that industry experts have often criticized the payday loan industry as targeting vulnerable consumers. People with more money and therefore, typically, better credit have access to more well-regulated products such as credit cards and short-term personal loans.
The new rules from the CFPB focus on ensuring that borrowers can afford to repay their debt without crippling their household budget. Among others, the agency will institute three major consumer protections:
A Full-Payment Test
This rule, according to the Bureau's announcement, will require lenders "to determine whether the borrower can afford the loan payments and still meet basic living expenses and major financial obligations." It will apply to any short-term loan that requires a full payment, but lenders who offer more structured payment options can skip this test.
To weaken the debt cycle triggered by consecutive rounds of lending, the CFPB announced, this rule will allow borrowers to skip certain consumer protections if the lender offers extensions and payment plans for borrowers who need more time.
Debit Attempt Cutoffs
Lenders can only directly debit a borrower's checking or pre-paid account with written notice, and can only do so twice without additional written authorization from the borrower.
In all, these protections are aimed at helping low-income borrowers manage their debt more effectively, the CFPB said in its announcement. Many of the new rules target the up-front nature of payday loans, both requiring and incentivizing lenders to offer structured payment plans that borrowers might find easier to pay off.
Not everyone is pleased with this, however.
Speaking with Consumer Reports, Dennis Shaul, the CEO of the Community Financial Services Association of America, argued that these new rules will make it much harder for low-income people to access cash.
"Millions of American consumers use small-dollar loans to manage budget shortfalls or unexpected expenses," he said.
And the demand is there. According to Pew Charitable Trusts research, nearly 5% of adults take out a payday loan in a given year. The demand is certainly there, and proponents argue that the industry fills a need by allowing people to cover in case of emergency and unexpected expenses.
Yet researchers argue that these claims are misleading. Experts say that the overwhelming majority of payday lending funds are used for everyday expenses such as groceries and bills and that approximately 75% of the industry's profits come from borrowers who have to take out more than ten loans per year.
Those borrowers may now have more options available than a year-long debt trap.
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