Given the current robust debate and dialogue regarding income disparity and wealth inequality, we thought it was timely to provide a perspective on one of the most overlooked, but pervasive instruments available to low income Americans, particularly in minority communities: payday lending. Considered by some to be a lifeline of last resort and others to be an example of an unregulated space that is profitable and predatory in its instincts and harmful to low-income families trying to simply make ends meet and break out of the vicious paycheck-to-paycheck cycle. Our view is more nuanced and pragmatic.
Due to the failure of the conventional capital markets to provide lending capacity to consumers in poor and distressed communities, payday lenders have emerged as the lender of first resort for communities who have limited access to the financial markets and who are underserved by the traditional banking systems. Consumers in these communities often live paycheck to paycheck, have limited emergency savings overall, in particular for emergency needs. Payday lenders capitalize on these market conditions and position themselves to fill a critical gap for these communities in the event of emergencies and other unforeseen financial events that can have a devastating impact on families. The payday lending industry presents itself as a viable alternative given the realities in the communities described above. Our belief is that while used surgically, payday lenders can fill a niche need, credit unions must play a stronger role in developing small dollar loan products and have a more visible and active presence in underserved communities to help close the gap. We will talk about a more viable regulatory environment later in this article.
On the debit side of the payday ledger we see institutions that can facilitate the erosion of savings in these communities in the form of high interest payments, and repeated fees (the average payday recipient uses an average of 6-7 loans a year at an average annual percentage rate of 400), one of the most expensive short-term consumer loans in the marketplace.
From a community development perspective these lenders absorb real estate spaces that can be focused on higher and better uses and often do not contribute actively to the enhancement of communities in key retail corridors.
Given the controversial and sometimes negative impact of payday lending, it is surprising to us that payday lending has not received more proactive attention by policy makers. This negative impact can be exacerbated by a lack of financial education, as well as the ease of getting these loans, repetitive payday lending can create credit and savings toxicity in these communities creating what is known as the “debt trap” which can destabilize communities economically over the long term. This trend has to be actively confronted and addressed if we are to build strong communities.
Consider some stories from the front lines: “Just don’t do it.” That is The advice of one Floridian who wound up stuck on a treadmill of debt after taking out her first two week payday loan, a scenario that far too many Americans confront, “You can’t get out from under it without starving yourself or borrowing more with higher fees,” said another borrower.
Another borrower, a teacher shared her story, “I got a loan to help pay my bills during the summer. I am a teacher and do not get paid during summer vacation. I did not receive summer employment and was unable to get a small loan from my bank. Using a payday lender was my only option. The loan amount was $500, repayment of $555 at interest rate of 167.29 percent. Loan payment was due on 6/30/14, I requested an extension to 7/7/14 because I do not have the money to repay the loan. I am caught up in a vicious cycle, robbing Peter to pay Paul. I may not be able to borrow the money from family or friends so I may have to request another loan.”
A blue collar worker stated, “It’s a revolving debt cycle that is as close to impossible as it can get without actually being impossible to get out of. You can’t get out from under it without starving yourself or borrowing more with higher fees. My story is: Borrow. Pay back with interest. Bills short. Borrow more. Pay back with interest. Bills short. Repeat as necessary.”
Unfortunately, stories like these aren’t unusual and, in Karen Landry’s work with the RAISE Florida Network, a statewide coalition convened by the War on Poverty-Florida, who has closely examined borrowers’ experiences over the past 2 years, notes “We consistently hear from residents across Florida that payday loans — with annual percentage rates in excess of 300 percent — are never the so-called financial fixes they’re cracked up to be. In fact, for far too many, these short-term, high-cost loans only wind up causing long-term financial distress.”
The RAISE Florida Network is a grass-roots coalition of organizations across the state of Florida whose mission is to promote awareness, education, resources and advocacy for economic security and wealth creation for families and communities in Florida.
When you look at the facts, the unaffordability of these products is clear. The data show that in Florida, 85% of payday loans are issued to borrowers trapped in seven loans or more per year. Furthermore, one in five borrowers is over the age of 55 and seniors are the fastest growing group of Floridians stuck in payday loans.
The concern of the payday loan debt trap extends to all of us, not just the individuals stuck in this financial quicksand. In a one year span from 2011 to 2012, payday lenders extracted more million in fees alone from Florida residents, and a study by the Insight Center for Community Economic Development found that payday lending resulted in a net loss of over $76 million in economic activity in Florida. Accordingly, it is important to note that the Center for Race and Wealth at Howard University analyzed four Southern states and found that Florida was the hardest hit by payday lending. The results show that in Florida the payday loan industry destroyed 2,150 net jobs, and reduced labor income, value added, and total sales by about $107 million, $308 million and $381 million, respectively. As a result of this loss in spending, many jobs in Florida were stripped from the economy causing a loss in total economic output.
Quick overview of payday lending
• Industry size: $7.4 Billion
• Number of payday locations: 20,000 storefronts and hundreds of websites
• Number of Americans using payday loans: 12 million
• Average size of loans, average number of loans per customer: $375 per loan, and repeat at least 8 times, paying $520 on interest
• Average length of payday loans and repayment cycle: 2 weeks; Lenders usually charge about $15 per $100 borrowed (390 percent annual percentage rate); and in some cases high
How can we end these high-cost, state-sanctioned debt traps? Smart, common sense regulations. Our best option — enact a responsible rate cap to reduce the cost of these 300 percent APR loans to our state’s usury limit of 30 percent. This would prevent the severe wealth stripping effects of these loans. Our own state legislators have the power to make this happen, but have thus far been content to sit on the sideline while individuals, families and communities across the state continue to suffer.
Floridians do, however, have a potential ally in a federal agency — the Consumer Financial Protection Bureau — which is currently working on a new, national payday lending rule that has the potential to end the payday lenders’ business model of making unaffordable loans. While this isn’t through a rate cap (by law, the CFPB doesn’t have the power to do that), the CFPB does have the power to make lenders do what nearly all responsible mainstream lenders already do — check a borrower’s ability to repay the loan.
Not surprisingly, payday lenders are not happy about this perceived threat to their extremely lucrative business model. Extending loans borrowers can’t afford to pay back ensures repeat business. In fact, 76 percent of payday loan volume comes from churned loans — i.e. repeat loans which are taken out within 2 weeks of a previous loan.
In essence, the CFPB’s ability-to-repay standard would ensure that payday lenders make loans borrowers can reasonably be expected to pay off, given their income and expenses, without missing payments on rent or utilities, or going without groceries and other necessities and creating more damaging credit issues. Most importantly, it would keep precious dollars in the hands of the borrowers and communities that need it most — available to be recycled vs. exported.
Some of elected officials would like us to believe Florida’s payday regulations are good enough for our residents, but it’s clear from the statistics and from borrower experiences that this is not the case. For the good of our community and communities across the country, sensible regulation, engagement and oversight of this industry occur, to include a robust consideration of the proposed CFPB regulatory framework.
Our recommendations for making payday lending more beneficial
• Regulatory reform and enhancement.
• Cap the rate payday lenders can charge at 30 percent.
• Assess borrower’s ability to repay, and provide longer repayment option (60-90 days).
• Spur innovation to provide loan products that are profitable for the banks and affordable to consumers. This competition could have a leveling effect on the interest and fees that payday lenders could charge, as they would be forced to react to market forces and a competitive landscape that would demand more competitive structuring.
Banks must do more to serve the needs of communities from a structural standpoint so that payday lending is only turned to in the worst case scenarios. Payday lenders should be accountable for responsible lending.
• Karen Landry is the executive director of War on Poverty, and Theodore Carter is chairman and former executive director for the Office of Economic Development, City of Jacksonville, Florida.
Please read our comment policy before commenting.