The Ins And Outs Of PayDay Lending

There are no shortage of divisive topics when it comes to finance and lending. But there are some special areas that manage to attract passionate debate among intelligent people that doesn’t merely divide debaters into two camps – but instead maybe three or four.

On such special topic is small amount, short-term, high interest loans – known more colloquially as “payday lending.” It’s a topic that attracts passionate, if not always entirely rational, debate.

“We gotta be careful. There are people who say there has never been a problem with the product, and there are also people saying anyone who takes one [a payday loan] out is in a cycle of death,” Nathan Groff, chief government relations officer for Florida-based Veritec Solutions LLC told MPD CEO Karen Webster in a recent conversation.

Veritec creates and maintains database systems that help payday lenders comply with their state’s lending laws. As a backdrop to Groff and Webster’s conversation, the CFPB is currently in the process taking its first shot at writing rules for these short-term lenders. In early January this year, The Wall Street Journal reported that sources close to the matter suggest that the CFPB’s first attempts at regulating the $46 billion short term loan industry (which heretofore has been managed exclusively by individual state) will likely center on finding ways to require lenders to extend credit to those who can actually repay their debts.

Something that in Groff’s opinion will change the industry, not simply regulate it out of existence.

“I don’t think [the CFPB] has a bent to purposely kill off the small dollar market,” he noted. But he also told Webster that the problem is a tendency for regulators to talk about the short-term marketplace when they don’t fully understand its dynamics.

Namely what really constitutes consumer detriment and what it costs to serve this customer.

“At the end of the day, the product is successful in term of offering high-cost, short-term credit because it’s not a traditionally underwritten loan. Lenders are dealing with a riskier borrower with a thin or non-existent credit file.

“Every day we see people who are innovating in lending,” Groff observed. “They say, ‘we’re going to Facebook to use their data points, we’re going to fine-tune our risk metrics.’ And that’s great – but at some point, when you strip everything away, the fees have to get somewhat close to the risk the lenders are taking.”

The short-term consumer more likely than not has a troubled borrowing history, hence their use of the loan in the first place. According to Veritec’s data, the average short turn loan is for just over $300. The majority of users take out five or less per year, and around 14 percent of users take out a single loan, per year that they pay back within 22 days.

“I don’t think anyone can rationally find fault with anyone who takes out one pay day loan in 12 months,” Groff noted.

So these users, it seems, are using payday lending the way mainstream consumers use credit cards.

“When you strip everything away, credit unions that were successful in this space with their customers, were successful with the product itself at pretty high rates,” Groff noted.

What about those who priced the loans who worked within an FDIC program and priced without regard to the high-risk applicant pool?

“The banks that participated in it said while they were able to deliver the product, they lost money and instead of using it as a revenue stream, used it as a loss leader to try to get customers in,” Groff noted.

While that might be sustainable for some banks, Groff said for the majority of lenders, no matter their method, there is an essential truth of lending that is not flexible.

“If they don’t get paid back or lose money, it’s not a success,” he noted.

And this is important, because it is an area where some of the angrier concerns about payday lending scratch at the borders of rationality, particularly the belief that the entire short-term loan industry exists to hand money out to people who can not pay.

“All of the market is going after people who can’t pay them back? That’s ridiculous,” Groff told Webster. “There are vulnerable people out there who end up head over heels on a loan. That said, I think the majority of our lenders deal with their customers fairly and follow the law. But there have been many lenders who have fought hard to not change aspects of their problem that they know are causing a problem.”

That problem is often observed in states where caps on the number of loans an individual borrower can have out are not well enforced because there isn’t a mechanism by which companies can even gather that data. Unlike traditional lending, short-term loans aren’t generally reported to the big three credit agencies. This does mean that there are places where secondary lenders – those who thrive mainly on a model where they turnover their loans often and profit by fees – can thrive easily.

There is also the problem of illegal lenders -those operating off of Indian reservations or offshore who are not subject to any regulation, or at least weren’t until very recently thanks to Operation Choke Point.

However, Groff noted that in states where it’s easy for consumers to get multiple loans, and it is easier to allow consumers to put themselves head over heels, statistically it happens more often.

“Can you say the lenders themselves conspired to do that? No. The system was just set up to abuse the product. We know, and we’ve known for a long time that there is a percentage of consumers in states with small dollar lending that are taking multiple loans from multiple lenders when they have no ability to pay, why wouldn’t the market want to address that?” Groff asked.

Why not indeed, since it seems in states like Florida where database systems like the one Groff’s company provides, default rates tend to go down, as do incidences of multiple loans. If there are low-hanging fruit solutions like this, why isn’t everyone snapping them up, Webster asked.

And, as it turns out, because some of it is just politics.

“There’s still a lot of money to be made by companies that don’t want to see the rules change and enforced.”

Moreover, Groff noted, there are plenty of opponents to the institution of short-term credit in general who don’t want to see it improved through regulation, they simply want it abolished as necessarily predatory.

And it’s not all solvable in one shot, notes Groff. There are ways to skirt regulations, and regulators don’t have the manpower or inclination to study that many lenders that quickly. There are also borderline and facedly illegal lenders complicating the space.

““There’s no silver bullet in this space. What we see is the payments and lending space coming together,” Groff explained. “The customer wants to get cash when they want to get cash, they want to be treated fairly and policymakers want to make sure there aren’t tipping the point where people get head over their heels and cause other societal problems.”

So how does this space move forward?

Well, for starters, Groff observed, it would probably be helpful if everyone involved used the same terms.

Take “rollover” for example.

In reference to payday lending, it generally means when the lendee continues their loan out without paying it off – generally for a fee. On a $200 loan, the fee on average is about $30, according to Groff. That’s generally included under a single umbrella by the CFPB as a “continuous loan.” Also under that umbrella is a consumer who gets a loan, pays it back, and takes a new loan shortly thereafter.

“At what point have consecutive loans caused consumer detriment? That has not been proven,” Groff pointed out. “The CFPB has not put out any data or any research that someone even has 10 consecutive loans in a year it causes detriment.”

Which gets to the other great difficulty – showing where the harms come into play.

There is no correlation between payday lending or bankruptcy that data can demonstrate. But then, Groff notes, that’s unsurprising since the people who tend to get them already have ruined credit and short-term loans are small.

“There is no one in Florida who is filing for bankruptcy over a $550 debt.”

It isn’t that there isn’t harm associated with short-term lending, Groff noted, it’s just that those problems may not be associated with taking out multiple loans. That makes the consumer detriment problem, at least so far, a bit sketchy.

“We still don’t have evidence of consumer detriment at a specific consumer amount.”

And, according to Groff, the CFPB hasn’t really defined consumer detriment, past the fact that it is tied to payday lending in some cases and to be avoided.

“How do you balance consumer protection and the availability of credit?” he asked.

That is the final question, and when it comes to payday lending, probably the overriding one and also the one with no easy answer.

“If you don’t want people to have credit, say you don’t want people to have credit,” Goff said. “If you want people to have credit through subsidies, the government should subsidize those losses through government intervention. Or you can let the market decide.”

Which sounds like the best option, provided that there is a mechanism to “control” the market practices so that neither consumers nor lenders can abuse the system.

But, the system can also cooperate better to stamp out illegal lenders, who exist online, are hard to distinguish and who are the locus of many of the payday lending horror stories. For Groff and Veritec’s part, their database – which separates the abusive lenders from the reputable ones who want to provide a service to a consumer at a fair price, is at least part of the solution.

“We say the database is agnostic and we’re simply enforcing the law,” said Groff.