Capital Commentary is the weekly current-affairs publication of CPJ, written to encourage the pursuit of public justice.
Seeking Just Lending Practices
Stephen K. Reeves
By Stephen K. Reeves
January 12, 2014
This article is the first installment in a two-part series.
An estimated twelve million Americans take out a payday loan every year. In recent years, small-dollar lending has ballooned into a multi-billion dollar industry, aided by a systematic and deliberate dismantling or avoidance of traditional usury laws that has allowed this exponential growth. The result is an industry built not on expensive loans given to risky borrowers, but on the creation of previously illegal loan products designed to act as debt traps for working Americans desperately trying to make ends meet. As widespread as the practice is, many do not understand how these products work, particularly those who will never need such a loan.
Twenty-five years ago, the storefront payday lender was essentially nonexistent; current industry members trace their heritage back only to the early 1990s. At present, fourteen states and the District of Columbia prohibit or tightly restrict the practice. In the thirty-five states that allow some type of payday lending, the storefronts are ubiquitous, particularly in working-class neighborhoods. The industry trade association claims over 20,600 are currently operating.
The Old Testament, Hammurabi, Plato, Aristotle, Dante, and Adam Smith all condemn usury. Throughout most of US history, there was common understanding of usury as immoral and unjust. All original states had strict usury rate caps of less than 8 percent. In the early 1900s, many states adopted a 36 percent rate cap for small loans. Since the mid-90s, the newly formed payday lending industry has worked to undermine state usury statutes. These efforts have included changes or exemptions to existing laws or the creation and exploitation of legal loopholes. While these laws and loopholes vary by state, the product, practices, and core business model are the same.
Payday loans are high-cost, small-dollar loans offered with no credit check required. The product seems deceptively simple, but it results in terrible complications for many customers. The name “payday loan” comes from the term for repayment—typically two weeks or until the individual’s next payday. While the borrower need only show a pay stub or other proof of regular income, lenders give little consideration to the ability of an individual to repay the loan given his/her other obligations, and within the original term. As a condition of the loan, the lender is given direct access to a bank account via a post-dated check or through electronic ACH authorization.
The typical interest rate and fee charges for a two-week loan range from $15-$25 per $100 borrowed. The annual percentage rate (APR) for these loans is frequently 391 percent to 700 percent and can climb even higher. Some states have no limit to the interest rate or fees that can be charged. At the end of the loan term, the borrower must either pay the entire lump sum, principal plus all interest and fees in one balloon payment, or have that amount automatically deducted from his/her bank account. As an alternative, the borrower can pay only the fee and interest and “roll over” the loan for another two weeks. At this point, despite having paid the hefty interest and fee, the borrower will still owe the entire principal plus another round of fees and interest. Lenders rarely accept partial payment beyond interest and fees, which ensures that the principal owed is never reduced.
While marketed as a short-term solution for emergency expenses, neither is typically the case. According to borrower surveys, 69 percent of loans are used for routine, recurring expenses, and the two-week loans often result in five months of debt or more. A loan of $350 will commonly cost a borrower $800 or more to repay—frequently even three to four times what was borrowed. When borrowers are able to repay under the initial loan terms, the resulting hole in their budget creates the need for another loan. In fact, according to an analysis of 15 million transactions by the Consumer Financial Protection Bureau, 80 percent of all payday loans are renewed, rolled over, or are taken out within fourteen days of a previous loan being paid off. That same analysis showed that 75 percent of all fees generated from payday loans come from the 48 percent of borrowers who have taken out eleven or more loans a year. That is not a business model built on one-time, short-term loans as they are marketed to the public and sold to policy makers.
These products are not loans in any traditional sense; they are self-perpetuating, fee-generating devices whose structure creates a perverse profit incentive for borrower failure. The more the borrower fails, the more money the lender makes. What has been referred to by many as a “cycle of debt” is not an unfortunate accident, it is intentional and it is the most profitable scenario for the lender.
Industry members justify their products by pointing to the high demand for such loans. While certainly some people need small-dollar loans at times, no one needs a 500 percent interest rate. There have always been and always will be people desperate for money. The question is what we as a society do about those willing to exploit that desperation for profit.
- Stephen K. Reeves serves as the associate coordinator of partnerships and advocacy for the Cooperative Baptist Fellowship based in Decatur, GA.
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Capital Commentary is a weekly current-affairs publication of the Center for Public Justice. Published since 1996, it is written to encourage the pursuit of justice. Commentaries do not necessarily represent an official position of the Center for Public Justice but are intended to help advance discussion. Articles, with attribution, may be republished according to our publishing guidelines.”