Businesses rarely succeed, let alone thrive, when repeated patronage is typically not in the best interests of their customers. But that is the paradox of the $46 billion payday loan industry, which makes more than three-quarters of its profits by harnessing borrowers into long cycles of continuing debt.
That is why it is appropriate for the federal government to consider the kinds of regulations proposed by President Obama to be administered by the Consumer Financial Protection Bureau. While we hesitate to support federal involvement in what essentially are local businesses, this seems an area appropriate for the new bureau to examine, especially given the inability of states to rein in some of the more predatory practices of the industry.
For example, 14 states do not allow storefront same-day lending while 29 others put some limits on how much individuals may borrow on an annual basis. Seven states, including Utah, put no cap on payday lending rates. In those states, according to a study by the Pew Charitable Trusts, the costs of borrowing are much higher than in places with ceilings on interest rates and fees. In Utah, the average annual interest rate for a payday loan is 471 percent. In Colorado, which puts a cap on rates, the annual interest averages 129 percent. The national average is about 391 percent.
While it is true that this sort of lending involves more risk to the lender than the type of lending done by traditional banks, and while the best way to compensate for that risk is through higher interest rates, the spread in interest rates among states is telling.
In addition, many who borrow from these businesses do so not fully understanding how interest accumulates, and payday lenders often aggressively urge borrowers to obtain more loans.
The rules proposed by the president do not constitute any kind of oppressive intervention into free-market practices. They simply would require payday and auto title loan companies to assess a customer’s ability to repay the loan, just as traditional banks are required to do. The lenders would be responsible to ensure the borrower is not taking on “unaffordable” debt, and rules would limit the number of loans people could take out annually based on their ability to repay.
"Too many short-term and longer-term loans are made based on a lender's ability to collect and not on a borrower's ability to pay," explained CFBP director Richard Cordray.
Indeed, the thinly veiled business model of the 22,000 storefront same-day loan outlets across the country is to snare customers into a loan cycle that gets deeper as time goes on. The CFPB reports that four out of five such loans are rolled over or renewed. Half of all loans are made to borrowers in a sequence lasting 10 loans or more. Nearly two-thirds of all borrowers renew a loan at least once and the majority of those people borrow as much or more than they borrowed the first time.
Creating repeat borrowers is just one part of the business plan; the other is to spend enormous amounts of money on lobbying to prevent or sidestep state regulation. Several attempts by the Utah Legislature to put restrictions on payday lending have failed before going to a full vote of the House or Senate.
The majority of borrowers are working-class people strapped by debt or facing immediate cash needs. It is unfortunate that people find themselves in such situations, with nowhere else to turn, but acting in a financially responsible manner is a two-way street. Payday lenders should be required to engage in responsible lending practices, which do not include luring borrowers into a bottomless pit of obligation.