Last week saw an important development in the long simmering public debate over “payday” lending. As most Utahns know, payday loans are relatively small loans, typically about $375, lent with an agreement to repay when the borrower receives their next paycheck. Payday loans have extremely high interest rates averaging about 400 percent per year.
By way of comparison, in their heyday, New York City mafia loansharking syndicates typically charged around 250 percent. Although each loan typically has a term of about two weeks, the overwhelming majority of borrowers — about 80 percent — cannot repay the entire loan when it comes due. Instead borrowers usually re-borrow by taking out another payday loan to pay off the first. For many consumers, payday loans become a debt trap. Payday loans are illegal in about 15 ideologically diverse states, from New York to South Dakota, and a federal 36 percent usury limit effectively prohibits making payday loans to any active duty military service member. In Utah, Payday loans were illegal for generations until the Legislature lifted all usury limits in 1982.
Now, for the first time, the federal government, through the Consumer Financial Protection Bureau, has issued a regulation specifically targeting payday loans made to the general public. In the wake of the subprime mortgage crisis, Congress outlawed any deceptive, unfair or abusive financial service practice, and gave the CFPB the authority to adopt regulations or bring law enforcement cases targeting these practices.
Recently, the CFPB used this authority to issue a regulation declaring that it is an unfair and abusive practice to make certain types of payday loans without reasonably determining that the borrowers have the ability to repay the loans according to their terms. The regulation follows years of research and study and a public comment period that saw over a million comments submitted to the agency. The regulation will require payday lenders to verify that borrowers have the income to repay their payday loans in full without defaulting on their other major financial obligations.
Payday lenders oppose the rule because they prefer to maximize the interest they can charge by loaning to borrowers that repay very slowly, thus enhancing their profits at the expense of helpless borrowers. The regulation is a common-sense, positive step for American families.
But the new rules face a tough uphill climb before they can improve the lives of working families. The regulations are not scheduled to go into effect for nearly two years. This will leave the powerful payday lending industry lobby ample time to convince Congress to repeal or water down the regulations. Voters and the press should keep a careful watch on Utah’s congressional delegation to see whether they side with their campaign contributors or their constituents in the months to come.
But even if the CFPB’s rules go into effect, without action at the state level, here in Utah most payday lenders will likely restructure their payday loans as longer duration installment loans that carry the same crushing interest rates.
Interestingly, the most promising forms of consumer protection have been emerging at the state level, often through ballot initiatives. Last November, South Dakota citizens voted overwhelmingly — with a 76 percent majority — to restore a traditional, conservative interest rate limit of 36 percent per annum. A well-crafted modern usury limit at this level leaves enough room to provide credit to even those consumers with problematic credit histories.
Montana voted to do the same thing a few years earlier. In both states, re-establishing the traditional usury limits that were the norm through most of American history is working just fine. The public still has access to credit cards, personal loans, home mortgages and even pawnshop credit. And banks and credit unions were hardly affected at all. The Utah Legislature should not wait for Washington to protect struggling families from usurious credit. And if the Utah Legislature will not act, then maybe the public should.
Christopher L. Peterson is the John J. Flynn Professor of Law at the University of Utah and served as a special adviser in the director’s office of the Consumer Financial Protection Bureau.
Josh Kanter is a lawyer, venture capitalist and the founder of the Alliance for a Better Utah.