Many Hoosiers are familiar with the payday loan store front. “Payroll Advances,” “Fast & Easy,” “CA$H” reads the store front’s marquee. The promise of fast and easy cash is coupled with predatory lending practices that often ensnare borrowers in years-long debt traps.
One Indiana borrower described taking a loan from an Internet payday lender when he was $400 behind on bills. When the 14-day loan came due and he couldn’t pay, he renewed the loan several times. “Within a few months is when the nightmare spun out of control,” he said. “I ended up taking out multiple loans from multiple sites, trying to keep from getting bank overdraft fees and pay my bills. Within a few months, payday lenders, who had direct access to my checking account as part of the loan terms, took every cent of my paycheck. My checking account was closed due to excessive overdrafts and my car was repossessed. I had borrowed nearly $2,000 and owed over $12,000.”
The Consumer Financial Protection Bureau (CFPB), a consumer watchdog group, plans to release a proposal that would regulate two categories of loans — short term loans, defined as having a repayment plan of less than 45 days and long term loans, defined as having a repayment plan of more than 45 days. However, long term loans would only be regulated if they have an annual percentage rate (APR) greater than 36 percent or are repaid directly from a borrower’s checking account, wages, or secured by the borrower’s vehicle. The proposal was published as a draft last year with organizations like the Center for Responsible Lending supporting some of its measures and criticizing others. The final proposal may be released as early as mid-September.
The CFPB has proposed a payment-to-income, or PTI, of 5 percent. This means that a lender cannot charge a loan repayment that exceeds 5 percent of a borrower’s income. Recognizing that income alone does not accurately depict a borrower’s ability to pay, the CFPB has proposed an ability to repay requirement that considers both income and major financial obligations, such as housing expenses, minimum payments on outstanding debt obligations, court- or government-ordered child support obligations, as well as basic living expenses. CFPB data shows that 40 percent of borrowers considered able to repay based on the 5 percent PTI still default on their loan.
The draft proposal contains loopholes, however, which exempt payday lenders from following the 5 percent PTI. For example, lenders can turnover the loan six times before they are required to offer a repayment plan on the seventh loan. Another loophole is that lenders are not required to verify income nor verify additional expenses.
A 5 percent PTI that does not consider other financial obligations further depletes low-income peoples’ already meager incomes and does little to stop the debt trap that ensnares the majority of borrowers.
Further, the 5 percent PTI threatens the strong protections in the states for which the 5 percent PTI, or even a 36 percent APR cap — a distant dream for some states — is regressive. Fifteen states and the District of Columbia have effectively banned payday lenders from operating within their borders by passing rate cap bills at 36 percent APR or lower.
The proposal may also affect mainstream financial institutions. The 5 percent PTI subverts guidelines issued by the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC), who in 2013, mandated banks evaluate income and expenses when disbursing loans repaid via the borrower’s checking account.
The CFPB’s proposal should introduce measures that stop the debt trap. The Bureau is barred from issuing caps on APR so structuring a PTI thoughtfully to anticipate loopholes is critical. Payday loans are designed to shepherd borrowers into immediately taking out — “flipping to” — another loan. In Indiana, 60 percent of borrowers take out a new loan the same day they pay off their old loan. Within 14 days, 77 percent have re-borrowed. According to CFPB data, over 75 percent of payday loan fees — revenue for lenders — come from borrowers who take out 10 loans or more per year. The debt trap is integral to the payday loan business model, sustaining its profit-making arm.
While mainstream financial institutions are known to misbehave, it behooves them to underwrite loans only disbursed to responsible borrowers. Payday lenders who have access to borrowers’ checking accounts and car titles lack this incentive. In a 2016 report, the CRL writes that “the market incentive to underwrite [the loan] is flipped on its head . . . The lender is counting not on the borrower’s ability to repay the loan, but rather on the lender’s ability to collect on the loan, whether or not the borrower can afford to repay it.” Research shows that payday loans increase the likelihood of overdraft fees, involuntary bank account closures, and bankruptcy. This predatory practice enables the industry to extract an estimated $70 million in finance charges each year in Indiana alone. Stronger consumer protections against payday lending would put $70 million more in the pockets of low-income Hoosiers.
The cycle of debt persists in Indiana despite provisions in our state law such as rollover bans and cooling off periods. The harms caused by these unaffordable payday loans are particularly detrimental to Veterans and communities of color, populations which payday lenders target and exploit. The CFPB is critical in creating stronger protections to defend at-risk consumers from payday loan sharks.
There is no evidence to support that competition among payday lenders drives interest rates down. Instead, research consistently shows that payday lenders charge the maximum APR permitted by state law. For example, Indiana caps APR at 391 percent and the average lender charges 382 percent. Advocates of the free market would argue that competition drives prices down. While that holds true in some markets, it fails to describe the reality of the payday lending market.
While the CFPB can enact certain consumer protections, it does not have the mandate to issue a 36 percent APR cap. Senators Joe Donnelly and Todd Young, along with other politicians, do. Write, call, or tweet your Senators to urge them to support stronger protections for Hoosiers — especially for more vulnerable consumers earning 80 percent or less of the area median income (AMI) who are more likely to use payday lending services. Indiana would join several states that had triple-digit interest rates, but have since capped APR at 36 percent, including South Dakota, Arizona, and Montana.
Contact Senator Young here, call 202-224-5623, or tweet @SenToddYoung.
Contact Senator Donnelly here, call 202-224-4814, or tweet @SenDonnelly.