Get your countdown clocks ready, because it appears federal regulators are preparing to drop a bomb on the payday lending industry. On Thursday, the Consumer Financial Protection Bureau proposed new rules that would completely change how the lenders do business, by preventing them from burdening customers with unpayable debts.
Unless you're Debbie Wasserman Schultz or a congressional Republican, chances are you won't be shedding many tears over this news. After all, payday lenders, which specialize in making short-term loans at triple-digit interest rates to cash-strapped customers, are the street-level face of predatory finance—one of the more grotesque manifestations of the fact that, in America, it is extremely expensive to be broke. And while many states have clamped down on their activity, others have let them run amok. A federal intervention was probably overdue.
In theory, the proposed regulations are designed to prevent the recipients of payday loans from overborrowing (these new restrictions would also extend to car title loans, a popular option in states that have limited payday lending). But they really strike at the heart of the industry's whole business model. The rules would require lenders to check their customers' credit and verify that they can afford to repay their loans whlie still covering basic living expenses. They would also make it harder for borrowers to take out one loan after another, as is now common. If borrowers wanted to roll over their debt, or take out a new short-term loan within 30 days of paying off a different one, they'd have to show that their personal financial circumstances had “significantly improved” (of course, rapid-fire payday borrowing is not typically a sign of financial health). After three successive payday loans, the customer would be required to take a 30-day "cooling off period,” during which they couldn't borrow any more. Finally, the new regulations would prevent lenders from whacking their customers with excessive penalty fees.
Successfully implemented, these rules would end payday lending as we know it, full stop. Currently, payday lending is extremely convenient for people who need money in a pinch, especially if they live in a poor neighborhood and alternative credit options are scarce. More or less anybody can walk into a storefront payday operator and obtain a loan, so long as he provides a recent pay stub and bank account information. Layering a whole underwriting process on top of that would make things more expensive for the lender, slow down the transaction, and obviously disqualify many potential customers from borrowing. Limiting the number of consecutive loans that people can take out would arguably be even more damaging to the industry, which profits richly off of customers who get trapped in debt. While the typical payday loan may last for only two weeks, the CFPB has found that 80 percent are either rolled over or renewed. “Half of all loans are in a sequence at least 10 loans long,” it has noted.
How much business would payday lenders stand to lose under these new rules? It's hard to say precisely. But earlier this year, CFPB ran a simulation that assumed the regulations would use a 60-day cooling off period, and concluded that storefront loan volume would drop 69 to 84 percent. Even if volume were to fall just 30 or 40 percent, it would be devastating to the industry.
Under the proposed rules, payday lenders can avoid some restrictions on who can borrow if they offer loans designed to be paid off in full after, at most, two renewals. But the CFPB thinks switching to that system would still cut overall loan volume by more than half, while decimating profits from fees. Point being, if these rules go into effect, they're going to give the industry fits. They would also probably inspire some creative workarounds. More lenders would probably try to operate online, moving their business offshore or setting up on Indian reservations. Some would undoubtedly try to create new lending products that aren't covered by the proposed regs. But the restrictions would be a blow. “I have no doubt there will be a new form of high cost lending. You’re going to see this cat-and-mouse game,” Mehrsa Baradaran, a law professor at the University of Georgia, and the author of How the Other Half Banks, told me. “But at least the cat is paying attention, and it’s a super cat.”
The question, then, is what happens to the customers? Currently, some 12 million Americans use payday loans. On average, they tend to be lower-middle class, rather than poor, and most say they use the credit to cover recurring expenses, such as food and rent, rather than emergency costs. Payday lending may be predatory, but there's also a real demand for it from a large swath of customers who need credit to get by.
There's a school of thought that says these people would be better off with no way to borrow, rather than face the easy temptation of walking to their local EZMoney or Cash America store. I once had a consumer advocate tell me outright that, “For people who can’t make it today on their regular income, the loan is not the answer.” Borrowers themselves typically say they would cut expenses, rely on family, or turn to a credit union or bank if payday lending weren't available. But it's hard to tell how realistic those options are for your typical payday customer—if they were realistic, you'd expect fewer people to rely on usurious, short-term debt.
Which is why, if the feds really are preparing to blow up the payday lending industry as it now exists, it's all the more important that we look for other ways for lower-income families to get short-term credit. That could include creating new incentives for banks and credit unions to pick up the slack (past efforts have been less than successful) or looking at something more radical, like postal banking. As Baradaran told me, “You really do have to pair any regulation of an incredibly popular product with an alternative.” Otherwise, you're going to end up harming the very people you're trying to help.