SOLUTION: Ethan Dorsett was a retired and disabled Marine living in Missouri. He struggled for five years trying to pay back a $2500 payday loan which had escalated to $50000 in interest due. Ethan’s plight began when his wife Emily slipped on ice and broke her ankle. Needing surgery she was unable to work in her retail job for several months. Her medical bills came to $26000 and she was ineligible for insurance at her work. With two children in college Ethan found himself unable to pay his wife’s medical bills. Ethan tried borrowing the money from family friends banks and credit unions. He had a “fair” credit rating but it was not good enough to borrow such a large sum of money.
Out of desperation, Ethan turned to store front lenders (another name for payday loan companies). He took out five $500 loans and paid interest every week. Every two weeks, each of the five loans carried $95 in interest for a total of $475 and he had to take out new loans to cover the old ones. Eventually, through taking various jobs over the five years, Ethan somehow got the loans paid off. It was tough. Ethan said “We ended up losing our home. We lost our car.”
Ethan was one of the fortunate ones. Not everyone is able to get out from under the burden of high-interest loans. Quite often, these type of store front loans are given to people in more desperate circumstances who are not able to pay off their loans like Ethan did.
Many consumers who take out payday loans are not as good a credit risk as Ethan. More frequently, payday loan borrowers are living on the ragged edge financially and end up borrowing, paying interest, and borrowing some more. Many end up going to title loan companies, which are somewhat similar to payday loans, where they end up signing over the title to their cars. One 66-year-old woman and her jobless son in Las Vegas took out a $2,000 title loan and pledged his 2002 Ford F-150 truck as collateral. Both say no one verified whether she or her son would be able to repay the loan, which carried 121.5 percent interest. When they finally paid the loan off, she said the company did not give them the truck title back, rather, the company talked them into borrowing another $2,000.
What Is a Payday Loan?
A payday loan is a short-term loan, generally for $500 or less, that is usually due on your next payday. Payday loans typically have the following characteristics. In addition to these loans typically being for a small amount and due on your next payday, they generally require that the lender is given access to the borrower’s checking account or they must write a check for the full balance in advance so the lender has the option of depositing the check when the loan comes due (on the borrower’s payday). SOLUTION: Ethan Dorsett was a Retired and Disabled Marine living in Missouri
Payday loans often have features other than those described. Though they are usually paid off in one lump sum, it is possible to set them up so that the borrower pays interest-only payments resulting in “renewals” or “rollovers” that may result in installment payments over a longer period of time.
The borrower may receive his or her loan in a variety of ways. It could be given as cash or a check; it could be received through funds loaded onto a prepaid debit card; or, the borrower could have the funds electronically deposited into a checking account. The finance charge for the loan (the cost of borrowing) may range from $10 to $30 for each $100 borrowed, which equates to an Annual Percentage Rate (APR) of almost 400 percent. To appreciate this rate, compare it with the APR on a credit card where the range usually runs 12–30 percent, depending on the card holder’s credit rating. SOLUTION: Ethan Dorsett was a Retired and Disabled Marine living in Missouri
Example: Let’s say you need to borrow $300 until your next payday, which is two weeks away. To pay it back, you will owe $345 assuming a fee of $15 per each $100 borrowed. Let’s assume you need to renew or roll over your loan. You get charged a $45 fee when the extension is over. That comes to a $90 charge for borrowing $300 for several weeks.
In addition to the fixed fees for a payday loan, other fees may be added on. If you renew or roll over your loan, for example, you will be charged an added fee and you still owe the original amount. In addition, if you do not repay the loan on time, you might be charged a late fee or a returned check fee. If your loan is loaded onto a prepaid debit card, there are other possible fees. These could include fees to add the funds to your card, fees for checking your balance, fees each time you use your card and/or regular monthly fees.
States Push Back
Payday loans are governed by state laws. Some states do not permit payday lending storefronts because the loans are not permitted by state laws. Or, some payday lending businesses may opt not to do business in a state because of its regulations. Twenty-two states have already regulated the industry, but in some states the industry has protected itself from regulations by making huge donations to the state lawmakers. Further, those donations are carefully targeted at key leaders in the legislature and to members of important committees when legislation has stalled or died in recent years.
Some states, such as Colorado and Indiana, say they have found a balanced approach to payday lending which keeps the payday loans available but heavily regulates them. In Colorado, many have praised the state for effectively reducing the interest rates on such loans by two-thirds and slowing down the rate that the lenders can roll over the loans. Some say Colorado is the most consumer-friendly payday loan market in the United States, but others say that there is still evidence of repeat reborrowing and high default rates.
One credit counselor observed that before Colorado’s new rules, families with numerous payday loans, all from different lenders, would spend Saturdays driving all over town rolling over their loans, but now that doesn’t happen much anymore. According to Colorado state data, the number of payday loan stores has dropped from 486 before 2010 to 188. In addition, 15 states have effectively banned payday loans by imposing strict caps on interest rates.
New Federal Controls
Beginning in 2015, the relatively new Consumer Financial Protection Bureau (CFPB) began studying ways that payday lenders would be required to make sure that borrowers can pay back their loans. By spring 2016, it was becoming evident what the new CFPB regulations might look like. The draft of the new regulations issued by CFPB director Richard Corday was 1,300 pages long. Under the new regulations, payday lenders would be required to run full credit checks on prospective borrowers to check out their sources of income, need for the loan, and ability to keep paying their living expenses while paying the loan back. In short, potential borrowers would be subject to the same kinds of screens that banks and credit unions now use and for which the typical payday borrower cannot qualify.
The new regulations, of course, will make it difficult or impossible for the typical payday loan borrower to take advantage of the service because they likely will not meet the requirements for the loans. In addition, huge record keeping requirements being foisted on the industry will likely force the small, local lenders who have dominated the industry out of business, and favor the large firms and consolidators who can afford and manage the regulatory overhead.
The Google Ban
Just before the CFPB announced its proposed regulations on the payday lending industry, Google announced that it would no longer run ads for payday loans, a decision that would impact significantly the online-lending sector of the industry. Online loans account for about half of the payday lending market. The payday loan industry did not respond well to Google’s decision. They claimed the new policy was “discriminatory and a form of censorship.” The president and CEO of the Online Lenders Alliance said that Google’s new policy “will prohibit legal loans for many Americans who otherwise do not have access to the financial system.” She added, “The policy discriminates against those among us who rely on online loans.” In its defense, Google said that it hopes that fewer people will be exposed to misleading or harmful products.
According to a Wall Street Journal (WSJ) editorial, Google may be getting plaudits from some observers, but maybe Google’s motivations are not entirely pure. Apparently, the venture capital arm of Google’s parent company, Alphabet, has invested in LendUp, a company that offers short-term loans at high interest rates and competes with the payday lenders. Google responded that it planned to block LendUp’s ads too. The WSJ editorial also pointed out that Google had invested about $125 million in the online Lending Club and posed the question of how much that firm would pick up in business due to the ban.
Don’t Rush In
Supporters of the payday lending industry point out that the government should not rush into payday loan regulations. One writer pointed out that when the CFPB conducted a study of consumer complaints, less than 1 percent of the consumer complaints were related to payday lending. This was a small percentage compared to the complaints related to mortgages, debt collection, and credit cards, which made up about two-thirds of the complaints.
A further issue is that proposed new regulations would further reduce alternatives for consumers who already lack access to the banking system. The CEO of the Community Financial Services Association of America, which represents the storefront payday lenders, said “payday loans represent an important source of credit for millions of Americans who live from paycheck to paycheck.” He went on to say that we need to find ways to increase not limit the ways that these persons can get access to the credit they need. Pew Charitable Trusts research found that some consumers turn to pawning their belongings or borrowing further from families and that these were not good options for people in a financial pinch.
Questions for Discussion
- Who are the stakeholders in this case and what are their stakes?,
- Have you ever taken out a payday loan or title loan? What was your experience?,
- What is your evaluation of the corporate social responsibility of the payday lending industry using the four-part definition of CSR? Is payday lending an exploitive industry that snares borrowers in a never ending cycle of debt?,
- Is the industry socially responsible but some of its members are engaging in questionable practices? What questionable practices are most troublesome?,
- Given the strong need for payday loans on the part of some citizens should the industry be further regulated such that borrowers no longer have access? What are borrowers to do who do not meet the new federal regulations?,
- Is the title loan industry the same as the payday lending industry? How do they compare?,
- The states have regulated the payday lending industry. Should the federal government be getting involved with regulating this industry? What will be the effects of the proposed CFPB regulations?,
- What is your assessment of the Google ban? Does Google have a conflict of interests in imposing this ban?,
- Should the CFPB back off and let the marketplace and the states handle payday lending issues?