Pay day is not as sweet when the thought of paying many times what you borrowed looms over your head.
Last week, the Bureau of Consumer Financial Protection (CFPB), wielding its rulemaking power, set in motion a plan to regulate payday loans.
Concerned with the payday industry’s repeat short-term lending, penalty fees, and high default rates, the CFPB has proposed a new rule for the $38.5 billion industry that “would require lenders to determine whether borrowers can afford to pay back their loans. The proposed rule would also cut off repeated debit attempts that rack up fees and make it harder for consumers to get out of debt.” The proposed rule addresses the fundamental drawback of loan rollovers trapping borrowers in a cycle of debt.
Many Americans live paycheck-to-paycheck, where one unexpected expense or event can mean the difference between maintaining and a rabbit hole of debt. Capitalizing on this deficiency, payday loan lenders offer quick, short-term, high-interest loans to consumers. The loan is effectively an advance on an upcoming paycheck. One of the major problems, however, is the interest rate on the loan – it is extremely high and can easily cause the rabbit hole to collapse into a water-filled abyss.
Payday loan interest rates are as high as 390%, whereas usury rates tend to be between 25% and 48%. As a consequence of their usurious nature, payday loans are banned in some states. For example, states like New York and New Jersey, prohibit predatory payday loans all together. Even more, consumers in those states may be awarded up to $1,000 in a civil lawsuit if a third-party debt collector so much as attempts to collect the debt. In addition to a statutory award of up to $1000, consumers may also put the CFPB on notice by filing a complaint.
In addition to extremely high interest rates, payday loan ‘debt traps’ are also made up of renewal and bank penalty fees. Borrowers who are unable to repay the loan can simply renew the loan and pay the fee again. According to the CFPB, research shows that 90% of the industry’s fees came from consumers who borrow seven or more times. If a borrower does not opt to renew the loan, the payday lender can debit the borrower’s bank account. If there aren’t sufficient funds in the borrower's bank account then the borrower will incur overdraft fees. The CFPB reports that “half of online borrowers rack up an average of $185 in bank penalties because at least one debit attempt overdrafts or fails”. As a natural result, consumers who were struggling before borrowing become ensnared as their debt continues to bloat and their banks assess overdraft penalty fees.
Here’s CFPB video on how payday loans work:
The Federal Trade Commission has also been cracking down on the payday loan industry.
“The agency has filed many law enforcement actions against payday lenders for, among other things, engaging in deceptive or unfair advertising and billing practices in violation of Section 5 of the FTC Act; failing to comply with the disclosure requirements of the Truth In Lending Act; violating the Credit Practices Rule’s prohibition against wage assignment clauses in contracts; conditioning credit on the preauthorization of electronic fund transfers in violation of the Electronic Fund Transfer Act; and employing unfair, deceptive, and abusive debt collection practices. The FTC has also filed recent actions against scammers that contact consumers in an attempt to collect fake “phantom” payday loan debts that consumers do not owe. Further, the FTC has filed actions against companies that locate themselves on Native American reservations in an attempt to evade state and federal consumer protection laws.”
- Docket No. CFPB-2016-0025
- MEMORANDUM OF UNDERSTANDING BETWEEN THE CONSUMER FINANCIAL PROTECTION BUREAU AND THE FEDERAL TRADE COMMISSION