Payday Lending’s Long, Strange Trip Through 2016

The Problem With PayDay Lending

There is neither a shortage of controversial topics in financial services or financial technology nor a shortage of subjects that tend to polarize people.

But short-term lending — in all its many forms, including payday loans, auto-title loans and some installment loans — is especially good at arousing passion in those who debate it. Arguments about payday loans have a habit of quickly devolving from polarized to outright acrimonious pretty quickly — and 2016 has seen that habit get very, very ingrained.

That is because after almost two years of speculation on the subject, as of early January it was clear that Consumer Financial Protection Bureau (CFPB) was finally going to release proposed new regulations for the entire short-term lending industry. Those regulations dropped in June and essentially boil down to four big changes for short term lenders nationwide:

Lenders will be required to establish a borrower’s ability to repay.

Individual loan payments per pay period must be limited to a level that would not cause financial hardship.

Payday lenders are not to allow consumers to reborrow immediately or carry more than one loan.

Lenders can attempt to directly debit payments from borrowers’ accounts a limited number of times in the event that there are not sufficient funds to cover the loan payment.

Proponents of new regulation have lamented that the rules didn’t go further but have spent the year arguing passionately that stringent regulation is absolutely necessary because at their worst, payday loans — and other forms of short-term lending — trap consumers in unending cycles of mounting debt though staggeringly high fees and murky loan repayment conditions. These abuses need to be stopped, and cheerleaders for the new regulations note that stringent rules and enforcement are the best way to get there.

Opponents of the regulations argue that rules as written aren’t an attempt to reign in short-term lending, but a regulatory attempt to simply stamp out the vast majority of it by making it too costly and difficult for most short-term lenders to stay in business. Consumers, they argue, aren’t actually well-protected by prohibition, because it means a lot more customers in need of funds won’t be able to access them.

Caught between these two groups are, of course, payday loan customers themselves — a group often speculated upon but rarely actually interviewed and thus often poorly understood. These customers have two equally important needs: not being taken advantage of by unscrupulous lenders and not being completely locked out of the credit markets. Regulation, Dr. David Evans recently noted, has tended to focus nearly entirely on the first side of that equation, with very little thought given to the latter part.

“It is time for a reset,” said Dr. Evans. “Time to recognize the importance of lending for consumers and small businesses and for making the economy go ‘round and ‘round. To recognize the valuable role financial service providers play in making loans for all sorts of reasons, for all kinds of people. And time to put the consumer back into consumer financial protection.”

So how does one get the consumer back into consumer financial protection — and actually hit a reset button?

It’s not a bad idea to understand that custom a bit better and understand how we got here.

Luckily, we have a handy roadmap right here — the PYMNTS PayDay Loan Chronicle 2016. This includes all of the data on all sides of the issue and anything else you might want to read on the road to new regulations.

Spoiler: The situation is more complicated than you’ve heard.

Chapter 1 – The PMYNTS PayDay Lending Primer

(The Whos, Whats, Wheres, Whens, Whys and Hows Of Short-Term Lending)

So who is the typical short-term loan borrower? Not the person most people think. Many media narratives on the subject are off the mark since they tend to focus on low-income borrowers who exist unbanked on the edges of the financial mainstream.

This 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. Second, unbanked and unemployed people are largely ineligible for short-term loans.

The typical payday-lending customer, according to the Pew Charitable Trusts, is a white woman ages 25 to 44. Data out of the Fed indicates that 47 percent of consumers would not have $400 in cash or credit resources to pay for a sudden expense, which would at least seem to indicate that there are an awful lot of middle-class customers who are either tapping short-term loans — or are one car repair away from needing to.

As for what happens when customers take out a loan — the data tends to trend in distinct directions.

For a large number — but not the majority 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 has noted, those fees are often exacerbated by overdraft fees if attempts to remove the lump sum loan payment encounter an insufficient funds bounce or two.

Some consumers pay back their loans without renewing them at all.

There is also a large class of multiple renewers (customers who tend to roll their short-term loans over) who settle up without a “never-ending cycle of debt.” For those customers, 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.

Also a bit different from how most casual observers picture them: 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.

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 financial institution (FI), that rate 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 net result is that most short-term lenders — particularly mom-and-pop shops — run on rather thin margins. A big spike in costs — say, from having to evaluate the repayment ability of each of their customers — would likely put most out of business.

So where do customers go in the absence of short-term lending?

Short-term loans are not really a line of business that anyone is looking to go into other than those already there. 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.

Consumer advocacy groups’ favored solutions involve 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,” noted 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.

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 — like Cumulus, which launched at Innovation Project 2016 — but how those solutions will function in new regulatory regime remains a bit up in the air.

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.

And in the absence of simple solutions, one tends to get some pretty heated arguments about what kind of complex fix should be put into place

Arguments that got started pretty much as soon as the confetti from last New Year’s was cleaned up.

Chapter 2 – Ugly On Capitol Hill

(The CFPB And Congress Clash Over Payday Lending)

Things between Congress and the CFPB didn’t exactly get off on the friendliest of feet in 2016.

This was probably because “The CFPB’s Assault on Access to Credit and Trampling of State and Tribal Sovereignty” was the official title for the first meeting between CFPB officials and members of the House Financial Services Committee this year.

We’re totally serious.

The meeting was officially about how the CFPB’s proposed regulations would affect tribal and state sovereignty — since currently oversight and authority over short-term small-dollar lending rests with them.

And the members of Congress in attendance were unsurprisingly unimpressed by the testimony of David Silberman, acting deputy director of the CFPB, that his organization is working in tandem with state and tribal regulations on payday loaning, not contrary to them.

“What we are doing is establishing a federal law, and the states will continue to be able to enforce their laws and their specific requirements, in addition to the federal floor that implements the obligation that’s been placed on the bureau,” Silberman said.

Subcommittee Chair Randy Neugebauer (R-TX) noted that the legislatures of 35 states have already enacted small-dollar lending laws of varying protections, including and up to outright bans.

The remaining 15 states, either by declining regulation or regulating through interest rates, had addressed the issue.

“Crucially, and contrary to the bureau’s appeal to a greater moral obligation, no state lacks the authority to enact, repeal or amend its own payday and lending laws in order to provide greater protections to its consumers,” Neugebauer noted.

Others, like David Scott (D-GA), were a little more passionate about the harms the CFPB might be bringing to the consumers they seek to protect, who, through the new regulations, could find themselves ineligible for a loan they need.

“Why are you trying to destroy small-dollar loans? We have 75 percent of American people living paycheck to paycheck,” Scott noted of the problems with the CFPB’s plans.

The problems created for temporary loan borrowers were something of a recurring theme during the hearing.

“Conversations about consumer credit often reflect utopian visions of the world. Many people imagine that a few tweaks to regulations can ensure that everyone has the money needed to feed, clothe and shelter the family,” Thomas Miller, Jr., visiting scholar at the Mercatus Center at George Mason University, said in his testimony before the committee.

“According to this logic, if households need to borrow money, lenders will treat them fairly, charge little and always be repaid. But no matter how hard we all try, a well-crafted regulatory framework cannot bring us this utopia. Deliberate, empirically informed regulators, however, can do much to preserve and expand consumers’ options along the nonbank-supplied, small-dollar loan landscape.”

In his remarks, Silberman noted that the CFPB was drawn to the payday lending landscape by the sheer volume of consumer complaints and the empirical evidence that it was harming consumers more often than it was helping them out of trouble.

Silberman also noted the bureau is still in the “early stages” of rulemaking and is committed to reviewing comments from businesses, consumers and others that were submitted last year.

“We’re listening to feedback,” he said.

What has that feedback sounded like?

We talked to both sides of the issue to get an idea of what they were looking for from the regulations — as well as their reactions to what they actually got.

Specifically, we talked to Jamie Fulmer, public affairs head for Advance America, the nation’s largest provider of payday loans, and Nick Bourke, director of the Pew Charitable Trusts’ small-dollar loans project.

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