Payday loans — the “lifesavers” that drown you in debt — are on the decline.
Fines and regulatory scrutiny over high rates and deceptive practices have shuttered payday loan stores across the country in the last few years, a trend capped by a proposal last summer by the Consumer Financial Protection Bureau to limit short-term loans.
Consumer spending on payday loans, both storefront and online, has fallen by a third since 2012 to $6.1 billion, according to the nonprofit Center for Financial Services Innovation. Thousands of outlets have closed. In Missouri alone, there were approximately 173 fewer active licenses for payday lenders last year compared to 2014.
In response, lenders have a new offering that keeps them in business and regulators at bay — payday installment loans.
Payday installment loans work like traditional payday loans (that is, you don’t need credit, just income and a bank account, with money delivered almost instantly), but they’re repaid in installments rather than one lump sum. The average annual percentage interest rate is typically lower as well, 268% vs 400%, CFPB research shows.
Spending on payday installment loans doubled between 2009 and 2016 to $6.2 billion, according to the CFSI report.
Installment loans aren’t the answer
Payday installment loans are speedy and convenient when you’re in a pinch, but they’re still not a good idea. Here’s why:
Price trumps time: Borrowers end up paying more in interest than they would with a shorter loan at a higher APR.
A one-year, $1,000 installment loan at 268% APR would incur interest of $1,942. A payday loan at 400% APR for the same amount would cost about $150 in fees if it were repaid in two weeks.
“While each payment may be affordable, if it goes for years and years, the borrower could end up repaying much more than what they borrowed,” said Eva Wolkowitz, manager at the Center for Financial Services Innovation.
You’re in the hole much longer: Payday installment loans are often structured so that initial payments cover only interest charges, not principal.
“The longer the loan is, the more you’re just paying interest up front,” said Jeff Zhou, co-founder of Houston-based Fig Loans, a startup that makes alternatives to payday loans.
Add-ons add up: On top of high interest rates, lenders may charge origination and other fees that drive up the APR. Many also sell optional credit insurance — not included in the APR — that can inflate the loan cost. Lenders market this insurance as a way to cover your debts in case of unemployment, illness or death. But the payout goes to the lender, not the borrower.
About 38% of all payday installment borrowers default, according to the CFPB.
Americans still want small-dollar credit
The demand for payday loans in any form isn’t going away soon. Twelve million Americans use payday loans annually, typically to cover expenses like rent, utilities or groceries, according to The Pew Charitable Trusts.
“The original two-week loan originated from customers’ demand for the product. Likewise, customers in many cases are demanding installment loans,” Charles Halloran, chief operating officer of the Community Financial Services Association of America, a payday lending trade group, said in an email.
Income growth is sluggish, expenses are up and more Americans are experiencing irregular cash flow, said Lisa Servon, professor of city and regional planning at the University of Pennsylvania and author of “The Unbanking of America.”
“It’s a perfect storm that’s very good for the expensive short-term creditors, not so much for the average American worker,” she said.
Newer fintech companies are finding ways to serve consumers with damaged credit
Mark Huffman has been a consumer news reporter for ConsumerAffairs since 2004. He covers real estate, gas prices and the economy and has reported extensively on negative-option sales. He was previously an Associated Press reporter and editor in Washington, D.C., a correspondent for Westwoood One Radio Networks and Marketwatch.
One argument that payday or small dollar lenders like to make is that they fill a critical need. They lend money, they say, to consumers who have an urgent need but can’t get credit anywhere else.
But many consumers now have another, less costly alternative in one of the emerging credit products specifically targeted to those with badly damaged credit. Yes, the interest rate is high, but not nearly as high as the 400% consumers typically pay to a payday lender.
A report this month, published in American Banker, had some encouraging news. It found that so-called fintech companies are creating credit products that may serve as a more affordable alternative to payday lenders.
Some are non-traditional sources of money and some, the report noted, require further evolution. But some take the traditional form of a credit card.
A recent entry is a company called FS Card, a start-up aimed at helping cash-strapped consumers meet an emergency expense. Its card is called Build and is available for consumers with credit scores between 550 and 600.
The company describes Build as “a transparent, flexible, and affordable credit card alternative to small-dollar loans and other types of expensive and restrictive short-term borrowing.”
One thing that sets Build apart is that it handles unsecured debt. Many subprime credit cards require a security deposit, often in the amount of the credit limit. In effect, consumers are borrowing their own money.
The American Banker report also highlights Elevate, a fintech company that has a division called The Center for the New Middle Class. The center’s mission is to develop affordable and manageable credit products for subprime consumers.
The gap between need and availability
“The fact that 69% of nonprimes are unable to cover an urgent expense of $500 with their savings highlights the gap between need and availability of borrowing options,” said Jonathan Walker, the center’s executive director.
Among the company’s products is Rise, an unsecured loan for consumers “living paycheck-to-paycheck.” However, it is not offered in all states.
Opportun is another lender with loan products for consumers with iffy credit. The company says it uses advanced data analytics and other tools to score consumers often considered “unscorable” by the three major credit bureaus.
“In recognition of Oportun’s goals of increasing economic opportunity for its clients, promoting community development, and serving low-income or underserved communities, Oportun is certified by the United States Department of Treasury as a Community Development Financial Institution or CDFI,” the company says on its website.
A recent report by the Harvard Kennedy School finds there is reason for optimism that subprime consumers will soon have even more alternatives to payday lenders. The report found that nearly all fintech products now available to those with low credit scores are better options than going to a payday loan store.
Darlene*, a single Toledo mom of two children who used to work two jobs and now has a Master’s degree, should have been living the American Dream. Instead, she was weighed down by the negative impact of payday lending.
Her story began with $500, the amount she initially borrowed to pay for necessities like repairing her car and the gas bill. “It took me two years to get out of that first loan. Every two weeks I had to borrow more. I had nearly $800 in bills every month. It was a crazy cycle.”
Unfortunately, Darlene’s story is not unique. The Center for Responsible Lending (CRL) has found that 76 percent of payday loans are due to “loan churn” – where the borrower takes out a new loan within two weeks of repaying an earlier loan. This allows payday lenders to exploit dire circumstances, and that immediate need for cash creates hefty profits from outrageous fees.
State Legislation to Rein In Payday Lenders
Toledo’s State Representative, Mike Ashford, is co-sponsoring legislation, H.B. 123, with Rep. Kyle Koehler of (R-Springfield) that would revise Ohio’s lending laws. The proposed legislation would ease the burden on short-term borrowers, who often pay the equivalent of 600-700 percent interest rates. Rep. Ashford says that current laws “make it impossible to pay off loans. As a result, Ohioans are living behind the financial eight ball for a long time.”
Local organizations in support of this legislation include: Advocates for Basic Legal Equality (ABLE), which provides legal services and advocates for low-income Ohioans; the Toledo branch of Local Initiatives Support Corporation (LISC), which uses charitable lending to transform distressed neighborhoods into sustainable communities; and the United Way. Those three groups have collaborated on a Toledo ordinance that would restrict the zoning for payday lenders.
Valerie Moffit, Senior Program Officer for LISC Toledo, says that H.B. 123 would be an improvement to “current payday lending practices [with high interest rates and repayment terms] that drive our families deeper and deeper into poverty.” Reiterating this point is ABLE attorney George Thomas: “We see [payday lenders] as predatory lenders. They’re extremely harmful and they take money out of our community.”
Community Financial Services Association of America (CFSA), a trade organization that represents Advance America Cash Advance and about 70 other payday loan companies, did not return a call for comment on the introduced Ohio legislation.