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One Payday Loan Won't Right a Ship, Might Push Some in to the Rocky Shoals

Adam Rust's picture

Posted March 27, 2015

One of the unique things about my employer, Reinvestment Partners, is that it touches consumers directly while simultaneously taking those concerns to decision-makers through policy and advocacy. BankTalk is a part of the latter endeavors, but its insights are enriched by what our organization sees in our community. Behind the scenes in Durham we are working with struggling households to resurrect their financial security.

Last year, from a city of approximately 260,000 people, we provided free tax preparation services to more than one thousand low-income filers. We helped a few more who needed representation in settling problems associated with previous tax filings. Until recently, we represented individuals who had legal complaints against mortgage servicers. We are still a HUD-certified housing counseling agency. This year we will meet with hundreds of folks who are at risk of losing their homes. We will negotiate loan modifications for as many of them as we can.  

One benefit of this work is that we develop relationships with lower-income households for long stretches of time. That tenure means we can get a fairly good take on their economic mobility. Most of our tax preparation clients have been coming back to us for several years. To some extent, that dynamic also carries across to the relationships we have with people who are at risk of losing their homes. As a condition of reaching an agreement for a loan modification, clients have to agree to come back for follow-up visits with our counselors. With the benefit of hindsight, we can see a lot about their finances. For some, a loan modification puts their finances back in balance. But unfortunately, this is not always the case. A hard truth about our economy these days is that many people never really recover from a disruption to their career. Once they lose a solid middle-class job, they often get labeled as damaged goods. For older workers, this is especially common. According to our counselors, when older workers do find employment after being laid off, many never enjoy the same level of compensation. They move from a salary of fifty to sixty thousand dollars per year down to a job paying wages of fifteen to twenty dollars per hour.

The truth is that they face difficult financial circumstances. But their troubles are not temporary. They were living paycheck-to-paycheck last year and they are likely to be in similar straits when they return next year.

Our clients are not going to be better off with a payday loan. True, an extra $350 dollars might take the edge off for a few days, but then things will be that much worse. There is an oft-repeated claim that payday loans help people through a rough patch, smooth out the peaks and valleys of income volatility, or help a family stave off eviction. Those might be true in some instances, but the statistics on the percentage of loans that must be renewed undermine that argument. About one in every two borrowers takes out another loan within the next month. More than half of all payday loans go to people who use the service more than six times per year.

As a said yesterday in Richmond, a payday loan will not right their ship. In fact, it might be the decision that sinks them.

The Field Hearing was a chance for advocates and industry to get a first look at how the Consumer Financial Protection Bureau plans to regulate short-term single payment and high-cost installment loans. Under the themes of prevent and protect, the Bureau outlined an approach that would hold lenders accountable at the moment of underwriting, during the repayment period, and even in subsequent debt collection efforts. There were easily more than one thousand people in attendance. Industry trade associations brought along scores of their employees. They were joined by a healthy group of advocates, faith-based leaders, legal aide attorneys, and regular people from Richmond. I sat behind a group of cashiers from the local Loan Store, a storefront payday lender within the QC Holdings franchise. Every one had dayglo yellow sticker bearing the phrase "Credit Access for All."

I speak for Reinvestment Partners when I say that these are good rules. Some of the highlights:

We support the ability-to-repay standard: Payday and installment lenders will have to be able to demonstrate that they underwrote credit applications based upon a review of a customer's income and expenses. This seems sensible, and it also sounds like a standard that should not elicit any objections from a well-intentioned lender.

Furthermore, we believe the proposal meets the important goal of protecting borrowers from falling into a debt trap. Before a borrower can slip into a series of rollovers, the lender has to document that there has been a change in the consumer's finances that would permit an additional debt service burden before more an additional loan can be originated. There is also a cooling-off period; borrowers who have taken out two or three loans during any two-month period will have to wait sixty days before then can take out another new payday loan.

We support the logic behind the Bureau's intention to require lenders to offer a repayment plan to borrowers. Under the proposal (or more exactly, the proposed proposal), lenders will have to offer some kind of means for borrowers to pay down their obligation. We believe that the Bureau has crafted a proposal that will help borrowers to escape from the "debt trap." Either the lender will have to gradually reduce the outstanding principal, or they will have to freeze new loans and create a step-by-step plan that lets a borrower pay off their debt without incurring additional fees. Since the inherent difficulty in making a profit through payday lending is overcoming loan losses, this should be another example of a regulation that should not interfere with the ability of a lender to generate a cash-flow positive enterprise.

The Bureau has ably addressed the "whack-a-mole" problem by creating a broad rule. A thorny problem with a payday rule is that lenders can avoid supervision as payday lenders by modifying their products to fit under the definition of consumer installment loans. There are similar prevent and protect provisions that will cover high-cost installment lending. As with single-payment loans, the lender has to document the ability of a borrower to afford the future loan payments. It is worth re-stating the significance of this point. An ability to repay standard is a sensible way to prevent trouble before it starts. This is a provision that should satisfy borrower and lender alike.

I know what people might say about an installment loan: it sounds like it must be much more patient than any payday loan. But it turns out that this is not always a valid assumption. One of the un-stated problems with some installment loans is that they mask what is essentially a pre-arranged sequence of rollovers. If it costs fifty dollars to renew a five hundred dollar payday loan and a similar amount in interest and fees for each payment on an installment loan of a similar size, then the difference between the two is not so great. If it ultimately costs one thousand dollars to repay a five hundred payday loan and nine hundreds to repay an installment loan of a similar size, then we are talking about two experiences that both fall well outside of what most would consider to be a reasonable cost for borrowing. Yes, the fact that a rollover adds to the principal does make the cost higher of a payday loan higher. But many installment loans impose additional add-on fees for credit insurance, credit life insurance, credit involuntary unemployment insurance, and property insurance.  The property insurance product sold by one installment lender (loans on retail goods) costs 5.9 percent of the loan principal per year. For a three year loan of one thousand dollars, this add-on increases the cost of financing by an additional $177. So while the loans are different, one is not necessarily better than the other every time.  

Thus, the CFPB's plan to Include the cost of credit insurance and other "add-ons" within the ability-to-repay standard is a significant benefit. 

Avoiding "loopholes" is difficult, but the CFPB's track record indicates that they will work very hard to mitigate against those kinds of efforts.  Loopholes are not the CFPB's style, as evidenced by the 800-page proposed rulemaking for prepaid cards, so if it puts its institutional mind to the question than it seems certain that this abuse will be ended.

Perhaps the best wrinkle is the proposal to make it impossible for a lender to tap a borrower's bank account without permission. Some unscrupulous lenders have a practice of sending a ACH request to an account tens or even hundreds of times. Ultimately what happens is that borrower closes the account, but before that happens, a lender's processor might have extracted every last dollar from a person's savings.  They can do that because they have a borrower's routing and checking account numbers and they have his or her permission to collect on the agreed-upon set of repayments. But sometimes, a lender (or the person who bought an outstanding loan from a lender) will continue to draft an account when there is no remaing debt obligation. This is illegal - but it happens. Even worse, it often means that a borrower has to pay overdraft fees on top of those fraudulent billings. The new rule would say that after there are two unsuccessful attempts, the lender has to secure the borrower's permission before it can ask submit another request for an electronic payment.

Towards the end of yesterday's field hearing, a man from Richmond stood up and said a few words that I thought summed up the meaning of the day. I'll paraphrase his words as best as I can:

"This is about money and government - two things that we will always have to bear in mind as long as we maintain a civil society. Money can be a fine thing, but where there is money, there will be someone who is willing to be unscrupulous. You know it and I know it. Everyone here knows it. You may not be one of those lenders. I hope that is the case. But you know that there are such people out there. Preventing that from happening is why we have a government. If that isn't the role of government, then I don't know what is. These days, I'm hearing people say that government is bad or government is unneeded. Well, come on. That's not true. The Consumer Financial Protection Bureau is doing something that should be OK to all of us. It is doing what we want government to be doing. Not stepping in to help the rich, but stepping in to help the common man. So thanks for hearing me out. Thanks for doing what you do, CFPB."