Both sides in the contentious debate over payday loans recently got a chance to make their case to national policymakers in the Consumer Financial Protection Bureau’s first-ever field hearing.
Payday loans are small cash advances with triple-digit interest rates lent for a short term to people who agree to pay off the loan with their next paycheck. You see payday loan businesses in stand-alone storefronts and strip malls, and some major banks even offer a version called deposit advances. Because of their hefty interest rates, lack of federal oversight and rapid industry growth, the loans have been a priority target for the CFPB.
The agency had been without a director since its debut in July 2011 until President Obama this month appointed Richard Cordray, setting in motion an ambitious agenda. First stop: a public hearing in Birmingham, Ala., which in December 2011 passed a six-month moratorium on new payday licensees, because the numbers were growing so rapidly. Alabama has one of the highest concentrations of payday lenders in the U.S.
Payday loan advocates say they offer lifeline
In Birmingham last week, industry advocates argued that payday loans offer a lifeline for millions of people who depend on that quick infusion of cash. According to the Community Financial Services Association of America, which sets industry standards for payday loans, storefront lenders made 110 million loans to nearly 20 million families in the U.S. last year.
Jamie Fulmer, vice president at payday lender Advance America, Cash Advance Centers, Inc., in Spartanburg, S.C., says consumers have to consider the costs of not getting the money — defaulting on bills and racking up fees. He argues that, if consumers add up the cost of defaulting on rent, getting utilities shut off and reconnected, and paying overdraft fees and banks’ and merchants’ bounced check fees, payday loans are far less expensive in comparison.
“When they look at the landscape of options … they will see that the payday loan product that we offer is a rational, cost-competitive alternative in that broader marketplace,” Fulmer says.
Consumer advocates call them predatory
Consumer advocates, meanwhile, used the Birmingham hearing to argue that lenders prey on the poor and shackle them with debt. The Center for Responsible Lending reports the average annual percentage rate (APR) for a 10-day loan is 417 percent. The average payday borrower takes out nine loans a year.
Shay Farley, legal director of Alabama Appleseed, a nonprofit legal advocacy group, says the industry needs regulation and change.
“We should call [payday loans] what they are,” she says. “It’s usury, it’s repulsive, it’s immoral and we should be offended at the practice. It is so destructive to our fundamental core values and yet we allow this practice to continue.”
One of critics’ main complaints about payday loans is that borrowers often end up rolling the loans over, meaning that, because they accumulate interest and fees, they have to take out another loan to pay off the first loan, feeding a continuous cycle of debt.
Farley says better alternatives include using credit cards, even if the person has to pay higher rates, or borrowing from family or friends.
Oversight is a challenge
Despite the financial risks payday loans pose to consumers, keeping an eye on lenders is difficult. Part of the problem with oversight is that each state has its own rules and regulations. Even within states, there’s often no central data bank that keeps track of how many of these loans are given.
In Alabama, Farley says, there are 1,069 licensed payday stores. There are seven databases for these loans alone, and it falls to a handful of people to regulate them as well as banks, mortgages, mortgage originators and title/pawn shops.
“There’s no way for me to tell you how many loans are given in Alabama, for how much at what rate and how many per person,” Farley says.
Another problem, Farley says, is the lack of three words — “in the aggregate” — in the state law governing small loans. Alabama law limits a lender to giving $500. But, because there’s no centralized database to check a customer’s collective (aggregate) loaning history, a customer can get $500 from a lender — and then $500 from another.
“And it’s not that they’re greedy, and it’s not because they want $1,000,” Farley says. “It’s because in two weeks they can’t pay off that other $500, and they have to go get more money to rob Peter to pay Paul.”
Advocates propose 36 percent cap
Stephen Stetson, policy analyst with the Arise Citizens’ Policy Project in Montgomery, Ala., says the best solution is to put a 36 percent rate cap on all small-dollar loans, which is modeled on the rate cap Congress established in 2007 for lending to members of the military. That’s a far cry from the current rate cap in Alabama, for instance, which is 456 percent for a $250 loan, according to the Consumer Federation of America.
Fulmer, of Advance America, says he’s heard that proposal repeatedly.
“Consumer advocates understand what that 36 percent means,” Fulmer says. “It’s effectively prohibition. … Applying a 36 annual percentage rate to a two-week $100 loan would mean that Advance America would only be allowed to charge $1.38 for that two-week period. That breaks down to less than 10 cents a day that we could charge for that $100 loan. It’s simply impossible.”
Stetson says any business that can’t operate on a 36 percent APR has a flawed business model. He says there is a place for federal regulation of these loans because a lot of the big national banks that are the money behind payday loans are already regulated by the Office of the Comptroller of the Currency.
“This is not a question of a few bad actors,” Stetson says. “This is a question of a faulty product.”
Educating consumers about the pros and cons of payday loans isn’t a viable strategy for solving this problem, Stetson says.
“There’s a time and place for financial literacy. You’re not going to out-advertise the industry,” Stetson says. “They stay open 24 hours. They give you a free turkey at Christmas. They have commercials with people throwing money at the camera. You’re not going to convince the public to go sit down in a credit union waiting room and apply for a small-dollar loan with a loan officer. You’re fighting a losing battle there, so this has got to be a regulatory thing.”
Meanwhile, both sides wait to see how the CFPB will move ahead.
Cordray said at the Birmingham hearing that the agency will work toward regulation that keeps the emergency loan option, but with more protections.
“I want to be clear about one thing: We recognize the need for emergency credit. At the same time, it is important that these products actually help consumers, rather than harm them,” he said.