What is a fair amount of interest to charge for a short-term loan? It’s unlikely anyone would say 300%. Yet that’s one likely outcome if the move toward installment loans among payday lending continues unchecked, according to a review of the payday lending market by The Pew Charitable Trusts.
In a report released yesterday, Pew finds 13 of 29 states where payday and auto title lenders operate, issue just single-payment loans usually due in two to four weeks, but the other 26 have started making installment loans over longer periods of time with high annual percentage rates between 200% and 600% .
Lacking further limits or restrictions, this is likely to continue, explains Nick Bourke, director of Pew’s small-dollar loan project. Some states have attempted to reform payday lenders, such as Ohio, which regulated the cost of payday loans to a maximum interest rate of 28% in 2008. But without further regulations, the change had an unintended consequence of pushing lending toward making costly installment loans where they could make a higher profit.
“Now we see the prices have gone up,” Bourke says, pointing to interest rates of 275% to 360%. “The loans aren’t pretty.”
Frankly, none of these loans are very pretty. And that’s the problem. The payday loan market is often the loan of last resort for Americans who lack better access to credit. After all, no one would choose to borrow $500 and pay back a total of $1,200 if they had more reasonable interest rate options. Yet as I wrote about in June, banks and credit unions which could provide short-term loans at a fraction of the cost are reluctant to get into the business without clear guidelines from the Consumer Finance Protection Bureau.
The CFPB draft rules released in June do not clarify the business for banks and credit unions, as Bourke told me at the time. It would seem a logical, natural solution for banks and credit unions to provide some type of short-term loan given that by definition payday borrowers must have a bank account already (payday lenders require direct access to an account for immediate payment.) The typical borrower earns about $30,000 a year, or $15 an hour, but may struggle month-to-month to pay bills.
Pew’s research in this area shows that in theory, installment loans would help borrowers by stretching the payment out over more time, rather than requiring the balance due in the payday loan’s typical two-week term. But without any regulatory guidance or limits, payday lenders’ installment loans often require too high a monthly payment of $200 or more, double what Pew’s research shows borrowers say they can afford. Payday lenders also offer refinancing, which usually incur extra fees and will roll the loan term out longer.
What’s a reasonable solution? Bourke would like to see safeguards that require affordable payments of 5% of borrower’s pay, restricting fees to interest charges, rather than also allowing origination fees which can encourage loan flipping, limiting excessive duration of loan terms – two weeks is too short, but a year is too long and capping noncompetitive rates – 300% is way too high.
Without such limits, “they can charge any fee, they can set any monthly payment,” Bourke says. “The lender gets virtually unlimited access to the borrower’s account or vehicle title.”
