When a borrower faces an unexpected cash shortage in advance of an anticipated paycheck, short-term credit offers the means to meet immediate expenses. One of the most popular types of short-term credit products is the payday loan, in which a borrower receives a small loan and pledges to repay it at an agreed-upon future date, frequently the borrower’s next payday. However, a report released by the Consumer Financial Protection Bureau (CFPB) this spring suggests that instead of simply bridging gaps in cash flow, payday lending frequently creates a “debt trap” for borrowers, in which they repeatedly incur fees exceeding the value of the original loans.
Congress created the CFPB to supervise both depository and non-depository financial institutions. Under this supervisory authority, the CFPB launched its first investigation into payday lending in 2012, releasing a white paper shortly thereafter focusing on the mechanics of the payday borrowing process and the risks presented by such short-term credit products.
CFPB Director Richard Cordray has explained, “[w]e are concerned that too many borrowers slide into the debt traps that payday loans can become.”
Payday lenders are typically non-depository institutions offering short-term loans in small amounts, generally $500 or less. These lenders do not engage in a meaningful underwriting process; typically they demand only proof of employment and personal identification. The payday lender often does not even consider the borrower’s credit score or any other financial obligations the borrower may have in originating the loan.
The payday loan is structured as a “closed end” transaction with the full repayment due at the end of a relatively short period, most commonly two weeks.The borrower typically writes a personal check or provides electronic account authorization to the lender, so that the lender automatically accesses the owed amount on the due date. The value of the balloon payment owed to the lender the amount of the loan plus a set fee, ranging from $10 to $100 or higher for each $100 borrowed.
If a borrower cannot repay the loan on the specified due date, most lenders provide the option of “renewing” the loan—paying a fee in order to roll over the loan to the borrower’s next payday. In its recent report, the CFPB focused on the frequency with which borrowers renew their payday loans in order to examine both the immediate and long-term effects of payday lending.
Analyzing 12 million payday loans, the CFPB found that over 80% of payday loans are rolled over, meaning that the borrowers have failed to provide repayment on the due date and opted instead to pay a fee in order to repay the loan at a later date. The report also examined the number of payday loans frequently taken out by a single borrower in the same “loan sequence,” finding that more than 60% of borrowers take out seven or more payday loans in a row.
Such repeated borrowing can result in substantial fees. According to the CFPB report, consumers who renew a standard payday loan six times will ultimately owe fees exceeding the value of their original loans.
Short-term, small value loans provide essential credit services to borrowers unable to access traditional banking products to meet their unexpected needs.As such, CFPB Director Cordray emphasized that any agency reforms of the payday lending market would “ensure consumers have access to small-dollar loans,” but would promote products “that help them get ahead, not push them farther behind.”
The regulatory landscape of payday lending varies tremendously across the United States, as such lending practices are governed by state law. States have historically regulated payday lenders through usury laws, imposing constraints on loan size, restrictions on fees, and limitations on the number of times a borrower can extend a loan.
Attempting to address the problem of repeated renewals highlighted in the report, some states have imposed required “cooling off” periods that restrict consumers’ ability to borrow additional funds following an initial payday loan. For example, Virginia usury laws prohibit a borrower from taking out another payday loan on the same day in which a previous payday loan is repaid. Other states have imposed bans on all payday lending.
Consumers may review and submit complaints about payday lending practices to the CFPB’s consumer complaint database.