For a busy mom scrambling to buy Christmas presents on a tight budget, a payday loan may sound like a great idea this week—as a way to take advantage of low prices during Black Friday.
Visit lending websites, and you’ll see lots of stock imagery of smiling (mostly white) people who look prosperous and cheerful.
Maybe, as payday loan ad copy often suggests, they had sudden car trouble and need $500 for repairs. They'll have that extra $500 as soon as their next paycheck arrives, so they’re just borrowing it until then.
Only that’s not how it usually happens.
New research from The Pew Charitable Trusts’ Safe Small-Dollar Loans Research Project suggests America’s estimated 12 million payday loan customers are likely to be African-Americans without a college degree and earning less than $40,000 annually. They’re probably separated or divorced and don’t own their homes. And they’re not having onetime emergencies or going on annual bargain-hunting expeditions.
Nearly 70 percent of those surveyed by Pew used their first payday loan to cover a recurring expense—utilities, credit card bills, rent. And a whopping 97 percent of them borrowed again, taking out an average of eight loans of $375 each per year and spending an average of $520 on interest.
Once they enter the cycle, it’s hard to get out. Here’s why:
Unlike other loans, payday loans must be repaid in full on the borrower’s next payday at annual interest rates of around 400 percent. Lenders usually request direct access to the borrower’s checking account to collect payment.
If the borrower actually had enough spare money in that next paycheck to cover the loan, it wouldn’t be so bad. But most don’t.
“The advertised price tag in a store is about $55,” says Alex Horowitz, a research manager at Pew who worked on the study. That $55 would be an affordable interest payment for most people, if they could pay their loan off slowly over time.
But if there isn't enough in their checking account on that next payday to fully pay back the loan, they’re hit with additional charges and perhaps overdraft charges from their bank.
Payday loans “exceed most borrowers' ability to repay,” Horowitz says, because they take about one-third of the average borrower's paycheck—money already needed for the next round of rent and bills. So the cycle continues.
How big is the problem? Pew estimates that 5.5 percent of Americans spend approximately $7.4 billion on payday loans each year.
Change Has Begun
Just as discriminatory mortgage lending is finally being tackled in the wake of so many foreclosures nationwide, some progress is being made on regulating the payday loan industry and educating consumers.
This week, the Consumer Financial Protection Bureau took its first action against a major payday lender by ordering Cash America International to pay up to $14 million in refunds to consumers for robo-signing court documents and illegally overcharging customers. It added a $5 million fine for these violations and for destroying records. The CFPB, a federal regulatory arm created in 2010 to protect Americans from faulty financial products, has also begun collecting complaints from consumers about payday lenders.
Also this week, Sen. Edward J. Markey, D-Mass., introduced the Military Savings Act to create a program in which financial institutions operating on military bases will offer “innovative financial products” to help troops and their families “decrease their need to turn to predatory payday lenders in times of financial crisis.” The bill is an amendment to the defense funding bill currently being debated in the Senate.
And Thursday, the FDIC finalized its guidance on bank payday loans, requiring banks to only offer these products to those consumers likely to be able to repay them.
The researchers at Pew recommend that all payday lenders change their policies by extending the repayment time frame and only lending to those who can afford to meet the terms of their loan.
Horowitz says many payday loan customers are on board with those changes, even if it means they won’t be eligible for payday loans anymore. More than 80 percent of those surveyed by Pew said if payday loans were unavailable to them, they would cut back on spending rather than borrow from some other source.
In states that enact strong legal protections against predatory lending, Pew found that payday loan usage drops—people don’t seek online payday loans from other states. In states with tough regulations, less than half as many adults report payday loan usage of any kind in the past five years, compared with states with the least regulation.
Will the CFPB soon require that all payday lenders only lend to people who have a clear ability to repay their loan?
“It's hard to speculate,” but “it makes sense,” Horowitz says. Because “as is, the products don't work as advertised.”