New Era for Payday Lending: Regulation, Innovation and the Road Ahead

New Era for Payday Lending: Regulation, Innovation and the Road Ahead

With online payday loans Oregon the creation of the Consumer Financial Protection Bureau (CFPB) under the Dodd–Frank Act in 2010, lenders who offer payday loan products fall under the direct supervision of a federal regulatory authority. As we move forward into this era of federal oversight of payday loans and other small-dollar loan products, there is a critical need for creative collaboration between the private, not-for-profit and financial technology (fintech) sectors in order to effectively serve the financial needs of low- and moderate-income (LMI) individuals. While each of these industry sectors has seen success in the past, data indicate that it is only through meaningful cooperation and innovation that we will be able to address the issue of LMI individuals’ lack of access to affordable small-dollar credit products with customer protections.

What Is a Payday Loan?

A payday loan is a short-term loan, generally $500 or less, that is normally due on the borrower’s next payday. Most payday loans, regardless of the lender, share certain key features:

  • Are for small amounts,
  • Are due within two weeks or on the consumer’s next payday,
  • Require the borrower to give the lender access to their checking account or provide a check in advance for the full balance that the lender can deposit when the loan becomes due; and
  • Are usually offered without a true verification of the borrower’s ability to repay or a credit check.

Payday loans can also be installment based and have rollover and/or renewal options. Annual percentage rates (APRs) on these loans can range from double-digit, near-prime rates to as high as 800 percent. In Texas, APRs average over 600 percent for these types of loans.

For many consumers, payday loans have served as a source of added means during times of financial hardship. While these high-cost loans do provide individuals with a temporary source of immediate funds, they also trap many people in a debt cycle. Borrowers usually qualify easily and are approved for these loans, then are later surprised by the unexpected financial burdens that result from their decision to access this form of credit.

Why Are Payday Loans Used?

Many borrowers see payday loan products as their only means of survival during periods of financial hardship. According to the Center for Financial Services Innovation (CFSI), most people use payday loans to cover unexpected expenses, misaligned cash flow, planned purchases or periods where they have exceeded their income. In a CFSI survey, 67 percent of borrowers cited one of these reasons as the primary driver for their payday loan usage, while the remaining one-third of borrowers cited two or more reasons. Most survey respondents identified unexpected expenses and exceeding their income as the leading causes for their use of this type of credit.

The Cycle of Debt

Payday loans are characterized by their high fees. For most borrowers, the loan amount itself does not pose a challenge to repayment; rather, it is the fees charged by the lender that so often consume them in an unending cycle of debt. When consumers are unable to pay off their loan, they are usually forced to pay outstanding fees and interest to keep the loan out of default status. With limited access to other sources of capital, these individuals find themselves stuck in a cycle of paying fees and interest while never actually paying down the principal balance on the loan.

Payday Lending in Texas

For both single-payment and installment loans, fees and refinances account for two-thirds of the revenue of the payday lending industry in 2015 (Chart 1). Single-payment loan borrowers typically had greater difficulty repaying their loans, which resulted in more than half of this category’s revenue stemming from refinances. Conversely, due to the high costs associated with installment loans in Texas, the majority of the revenue in this loan classification was from fees charged by lenders. This distribution reflects what national studies have also found in other markets across the U.S-that for each borrower, the loan principal accounted for only a small fraction of the total loan balance, compared to the loan fees charged. During 2015, the overwhelming majority of payday loans were for principal amounts between $250 and $500.