Fans of television – or more accurately, fans of television tropes are probably familiar with the concept of “The Berserk Button.”
The Berserk Button in a television show — or really anywhere in fiction — is whatever trigger one can trip or red flag one can wave in front of a character that will get them acting like a deranged madman or woman within mere moments of its mention.
Take calling Marty McFly a chicken, suggesting Walt White should stop selling crystal meth, making fun of mailmen in front of Cliff from “Cheers,” underestimating the power of the dark side around Darth Vader — whether it’s played for laughs or drama is a matter of degree. But the idea is always the same — a normal or at least reasonably well-controlled character, whenever triggered by whatever it is, immediately flips into irrational and belligerent mode.
We sometimes tend to forget that art imitates life and that reality is impressively chock-full of such buttons.
They tend to play out less colorfully than they do in fiction, but unfortunately with much more concrete and sometimes worrisome consequences.
Which brings us to payday lending and its proposed regulation – a subject that has turned out to be the Berserk Button for a shocking number of consumer right advocates, congressmen, regulators, Senators, preachers, industry representatives business people and consumers.
So far, 2016 – a year that is only 16 weeks old – has seen such a staggering amount of drama that it’s hard to recap without sounding like we’re exaggerating. There’s been name calling, insinuations of Biblical proportions of evil, double-crosses, triple-crosses, think-pieces, counter-think pieces and a pile of sturm and drang – unfolding in almost reliable weekly installment – as the CFPB is prepping to drop its big spring release: New Regulations For The PayDay Lending Industry.
So why all the fuss?
And that is where things get complicated, and buttons are getting pushed. Payday lending, lending in specific — and short-term lending in general — is a much discussed topic that is in many ways not well understood. Who borrows, who lends and what the alternatives to the system in place now really are remain questions that are more often argued about than explained, which has led to some strange ideas on the topic.
PYMNTS want to help and cut through some of that clutter in the week before the new regulations drop, with data upfronts on the areas that are most frequently and easily misunderstood.
Who Is The Typical Payday Loan Borrower?
As PYMNTS has pointed before, the typical narrative about the sort of borrower who taps into a short-term loan is consistently off the mark. The headlines and narratives on the topic, however, tend to focus on low-income borrowers that exist unbanked on the edges of the financial mainstream.
Which is precisely wrong for two reasons.
The first is that extremely low-income unbanked consumers don’t take out payday loans for the simple reason they mostly can’t — one needs an account to deposit funds into and a paycheck to use as collateral of sorts. Unbanked and unemployed is also largely ineligible for a short-term loan.
Payday loans are for working class and middle income consumers, a reality that it seems that PYMNTS is finally not alone in pointing out.
The Atlantic, in its most recent edition, pointed out that the the typical payday-lending customer, according to the Pew Charitable Trusts, is a white woman aged 25 to 44. Recent data out of the Fed indicates that 47 percent of consumers would not have $400 to pay for a sudden expense, which would at least seem to indicate that there are an awful lot of very middle class customers who are either tapping short-term loans — or are one car repair away from needing to.
The article noted some sources peg the number of Americans living paycheck to paycheck as high as 78 percent. One lender, Elevate Credit, noted in a financial filing:
“Decades-long macroeconomic trends and the recent financial crisis have resulted in a growing ‘New Middle Class’ with little to no savings, urgent credit needs and limited options.”
“These people are in unfortunate situations. We can argue whether or not the government should be doing more to create better paying jobs, more employment opportunities, or a social-welfare net. But the government isn’t doing any of that and so some people really, really need to borrow against their future earnings to make ends meet today.” — Karen Webster
Those macro-economic trends are boiling over in all kinds of interesting ways that anyone with CNN and the stomach to watch the presidential primary can enjoy. But the reality, as Karen Webster noted in her commentary yesterday, is that those financial factors are in fact a reality.
“These people are in unfortunate situations. We can argue whether or not the government should be doing more to create better paying jobs, more employment opportunities, or a social-welfare net,” Webster noted. “But the government isn’t doing any of that and so some people really, really need to borrow against their future earnings to make ends meet today.”
And that need, Webster noted, isn’t because they are hoping to spend extravagantly or because they don’t understand what a high-interest loan is. These are “middle-class people who happen to be living paycheck to paycheck,” they’re choosing short-term lending because it is likely their best bad option.
Except that it may or may not actually be a bad option, depending on the consumer. For a large – but not majority number of – borrowers, taking out a high interest short-term loan kicks off a cycle of debt that generates fees well in excess of the original loan amount that are paid before said borrower defaults under the collective weight of those fees continually stacking up over time.
As the CFPB was good enough to point out last week, that process can often be accompanied by racking up additional overdraft fees if attempts to remove the lump sum loan payment encounters an insufficient funds bounce or two.
The problem is it doesn’t always happen, or even happen a majority of the time.
Some consumers pay back their loans without renewing them at all, and even multiple renewers tend to settle up without an “never-ending cycle of debt.” A more accurate description might be a six-month cycle of very expensive debt. Multiple and escalating overdraft fees also aren’t the norm — about half of all consumers don’t ever overdraw and the vast majority never pay more than a single fee.
“Some consumers do use payday loans just as the industry markets them — as a short-term emergency source of cash, one that won’t be there if the payday-lending industry goes away,” The Atlantic noted in its recent story on payday lending.
And beyond actually managing to serve some consumers correctly, that same Atlantic article points out that payday lenders are not exactly who you might think either.
The Typical Payday Lender
While the more colorful pictures of payday lending one reads in media might feature dimly lit rooms where malevolent billionaires light cigars with $100 bills ripped from the hands of widows and orphans, the reality is that’s not happening in this particular industry. And note, we’re not actually making a moral statement at all, this is all business — even the titans of payday lending aren’t operating with thick or even comfortable margins. They don’t have the $100s to waste on cigar lighting.
For one, payday lenders lose a lot of money to default — an unsurprising outcome given they are known for lending to borrowers with a long track record of not repaying debt. Default rates are estimated at 20 percent on the low-end, while at a mainstream FI that is a lot closer to 3 percent on average.
That high default rate is paired with high overhead costs — opening and staffing a physical location is costly and underwriting volume tends to be low by nature.
The plans the CFPB is reportedly considering would include rules that would force lenders to verify borrowers can repay their loans and cover other living expenses without extensive defaults or reborrowing. Many industry advocates say such rules would simply legislate short-term lending out of existence since the business model could not support the simultaneous drop in loan volume and the increased underwriting cost.
And while until now many have just cheered that the wicked payday lenders are going away, there still remains those pesky customers from the first subjection, half of whom may or may not be able to put their hands on $400 in an emergency.
What happens to those customers?
The Alternatives Are … Not Really Alternatives
The problem so far has been that making short-term loans is not really a line of business that anyone is looking to go into. There has been some pressure on larger FIs to offer small personal loans, but there has also been pressure on larger FIs to get out of the business of offering loans of any sort to high-risk borrowers.
The CFPB’s favored solutions is credit unions and small banks popping in to fill the blank, since overhead for them is a sunk cost — and Richard Cordray thinks they could offer consumers more reasonable prices.
But though there have been a few pilot programs that have made it work, most credit unions that have tried were eventually forced to pull the plug; high default rates made these types of loans too risky and unprofitable.
“We are all cognizant that we should do it, but it is very challenging to figure out a business model that works,” notes Tom Kane, the president of the Illinois Credit Union League. In any event, the credit union industry is small. “The scale isn’t there.”
Other favored dreams include the Post Office acting as a low-cost, short-term lender — an idea with famous proponents behind it, as well as a host of critics quick to point out that there is no reason to think the Post Office would actually be good at being a bank since that has never actually been its purpose.
Technology-based FIs and online lenders are also a popular refrain for replacing the bad old payday shops, but even The Atlantic noted that these firms are new, largely unknown, even less easy to regulate and are often charging higher fees, not lower ones.
The big takeaway: There are options here, but no obvious white knights.
So What To Do Now?
Payday lending is a simple problem with no simple answer because it is not easy to profitably lend to a class of consumers who have a long history of not repaying loans — and to do so in a way that is profitable without charging higher interest rates than a traditional bank would offer a traditional customer who is able to get a traditional loan.
There are solutions – and good ones that are in the market today if one would only look. Innovators provide software solutions to payday lenders that tie into their points of sale and verify the status of the borrower, loan term, amount and interest rate according to State Usury laws. So, far 16 states have such a system in place and in those states there are no abuses of the system.
There are also alternatives to payday loans that innovators have also dreamed up. Cumulus, which launched at Innovation Project 2016, has created a novel Income Sharing instrument that is intended to be borrower and lending friendly by pegging repayments to a percent of the paycheck and only when there is a paycheck. And, in compliance with state regulations as well.
What probably won’t work, however, is to force conditions on lenders that don’t make it plausible for the people who need these loans to get them. There is, clearly, a middle ground where consumer friendly and lender feasible can stand together. We just need to find it.
We at PYMNTS believe good solutions are possible, but only if everyone starts with some good information and makes decisions with that in mind. While we don’t believe that there is any easy answer to solving the payday lending issues, the least we can do is to give you better data.
So, tune in over the next few weeks as we give you the in-depth data on this important topic.