For two decades, the payday loan industry has preyed on low-income workers by offering short-term loans with sky-high interest rates and fees. Now the five-year-old Consumer Financial Protection Bureau is taking the first major steps to curb the sector's predatory practices.
Under the proposed regulations announced this week, payday lenders must ensure that a borrower can afford the loan and meet his or her major financial obligations and basic living expenses. The rules would also limit the number of times a lender may withdraw money from a borrower's bank account without reauthorization after two unsuccessful attempts. The final rules are expected to take affect in late 2017.
Typically, a borrower goes to a payday lender company and writes the lender a check for a specific sum of money-on average, Americans write payday loan checks for $375. The borrower then receives cash. The lender cashes the check or, on the individual's next payday, withdraws the funds from the borrower's bank account.
Payday lenders do not require borrowers to offer proof of financial ability to repay a loan: To qualify, a borrower only needs to provide checking account details, valid identification, and pay stubs or other proof of employment. The proposed regulations would prohibit payday lenders from providing funds to borrowers who have not been prequalified for short-term high interest loans.
The payday loan industry rakes in $7 billion in fees annually. According to the CFPB, the median fee for every $100 borrowed is $15. Interest rates are astronomical, averaging about 300 percent or higher. Coupled with the repeated attempts to withdraw funds from the borrower's account, which lenders are permitted to do once the repayment period begins, repaying the loan can quickly become unmanageable.
"The most profitable borrowers are the ones who can't repay the loan," said Mike Calhoun, the president of the Center for Responsible Lending, a nonprofit organization that promotes fair financial practices, during a telephone news conference.
Most payday lenders set up shop in low-income communities and communities of color, areas that often lack access to mainstream banking institutions. "This vulnerability is what payday lenders are counting on," said Lindsay Daniels, the director of National Council de La Raza's Wealth Building Initiative.
The payday lending industry is pushing back against the consumer watchdog's regulatory push, claiming that these businesses provide a vital service to people with scant financial resources. Critics of the industry counter that borrowers have other options. "Even a pawn shop is better than these payday loans," said Hilary Shelton, the director of the NAACP's Washington Bureau. "Some credit unions make short-term loans available that are not as nearly predatory or costly," he added.
However, the proposed regulations are not a cure-all. Daniels says that the regulations don't go far enough to protect borrowers from practices like loan flipping, whereby lenders compel a borrower to renew a loan even though the individual has been unable to repay the original amount borrowed. "We are concerned that people will continue to experience problems because there are loopholes," she said.
