US: No More Payday Loans

26 May 2016 - 05H05

 

by Judith Stein and Biodun Iginla, France24 Financial reporters, Washington DC

 
 
 
 
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© AFP/File / by Virginie Montet | Offered outside the regulated banking sector, payday advance loans are usually provided by one of 20,000 storefronts across the US

WASHINGTON - 

Struggling to make ends meet, millions of Americans resort to so-called payday loans whose costly charges can devastate personal finances.

For the first time, the US government plans to implement a new rule that could limit the short-term, small-dollar loans that typically are due to be repaid on the borrower's next payday.

A proposed regulation is coming within weeks, says the Consumer Financial Protection Bureau, a federal agency created after the 2008 financial crisis that has been working for more than a year on the measure.

The CFPB proposal will be made public as early as June 2, people close to the situation told AFP.

"The main idea is that we don't want customers to get stuck in debt," said Samuel Gilford, a spokesman at the CFPB. "What is intended to be a short-term loan ends up a much longer-term financial obligation."

Offered outside the regulated banking sector, payday advance loans are usually provided by one of 20,000 storefronts across the nation.

Usually less than $500 is borrowed, for a period of two weeks or a month. To qualify, the borrower must have steady income and a checking account.

In exchange for the loans, the lender can require access to the borrower's checking account for repayment. Or the borrower writes a check for the full balance in advance, which the lender can cash in when the loan becomes due.

The finance charge on payday loans is much higher than regular bank loans or credit cards. According to the CFPB, a typical two-week payday loan charges $15 for every $100 lent.

That equals an annual loan rate of nearly 400 percent, while credit cards typically charge from 12 percent to 30 percent.

- Cycle of debt -

If the borrower cannot repay the loan, that can lead to a pernicious cycle of more borrowing and more finance charges.

"You borrow $300, you are going to owe $350 in two weeks. In two weeks, if you don't have those $350, you can maybe come up with the $50, pay that interest and reborrow the $300. That's the most common scenario -- people will typically roll over their loan," said Gilford.

A study by Pew Charitable Trusts, a nongovernmental research and polling group, said that "most borrowers pay more in fees than they originally received in credit."

Payday loans have become increasingly criticized as consumer rip-offs, and consumer rights advocates have clamored for a clampdown in the practice, seen as widely targeting the poor and minorities.

Google recently announced it would ban ads for payday loans and auto title loans, in which borrowers pledge their vehicle as collateral to obtain modest loans at high interest rates, saying: "This change is designed to protect our users from deceptive or harmful financial products."

- 16 million borrowers -

But payday loan industry professionals say their service is a crucial source of financing as banks move away from small, short-term lending due to the high costs.

Those borrowers "are not going to be serviced by banks," said Dennis Shaul, chief executive of the Community Financial Services Association of America, which represents nonbank lenders.

According to the CFSAA, 16 million Americans borrow about $38.5 billion annually in payday loans.

That volume may seem negligible compared with $3.5 trillion in annual US consumer credit.

But payday lenders help the 5-6 percent of the population whose pay is "volatile", acknowledged Nick Bourke of Pew Charitable Trusts.

The CFPB lacks the authority to cap interest rates on payday loans. The thrust of the new rule would be to limit payments to five percent of the borrower's income. It aims to make it easier for borrowers to repay the loans.

The rule is raising a furor among payday lenders. For example, Bourke explained that the average borrower has annual income of $30,000, or $1,250 every two weeks. That would prevent them borrowing even $300 a month because it would be above five percent of income.

Shaul said the aim of the CFPB rule "is to diminish or eliminate the industry."

It will, the CFSAA says, create "a convenient entry for traditional banks but at the same time leaves millions of customers without access to short-term credit."