The New York Times, November 16, 2013
At some point â soon, we hope â the Federal Consumer Financial Protection Bureau will issue regulations for the payday lending industry. The bureau took an important step in that direction when it announced earlier this month that it would begin collecting complaints from borrowers who may have been hit with unreasonable fees, unauthorized withdrawals from their checking accounts or other abuses. The bureau should rein in all of these practices, but its most important task is to ensure that the loans are affordable â which means requiring lenders to determine in advance that the borrower has the ability to repay.
Payday loans, used by 12 million borrowers annually, are not what they seem. They are advertised as convenient short-term transactions, but in fact the lenders generate profit by trapping borrowers in debt for as long as five months. The way it works is that borrowers take out small loans (averaging $375) and promise to repay the entire amount on payday, typically two weeks later.
But only about 14 percent of the borrowers can afford to repay the loan in full, according to a new study by the Pew Charitable Trusts. The rest can only afford to repay part of the loan, which forces them to renew the loan again and again, at a cost of about $50 a pop. In the meantime, lenders often trigger overdraft fees by trying to withdraw money from the accounts of borrowers who have too little on hand to meet the obligation. In the end, the hapless borrower can pay as much as 400 percent in interest.
Fifteen states have outlawed such exploitive lending. But the remaining 35 still allow payday lending that requires the full amount to be paid at once. After analyzing data from all over the country, Pew sensibly recommends that state and federal regulators forbid lump-sum repayment requirements, ensure that lenders clearly disclosure terms and require lenders to spread out payments over months rather than weeks.
Regulators should also limit high-cost upfront fees, because they create an incentive for lenders to push borrowers into new loans as a way of driving up profit. These changes would mean less profit for the lenders but would protect low-income borrowers from being bled dry.