According to a survey by Bankrate, roughly 25 percent of Americans live paycheck to paycheck. The money they make just barely covers their day-to-day expenses, with little or nothing left over for emergencies. If you’re in this situation, any unplanned expense – such as a $300 car repair – can cause a financial crisis.
Laws about payday lending
The laws about payday lending vary from state to state. States fall into three basic groups:
• Permissive states. In 28 states, there are very few restrictions on payday lending. Lenders can charge $15 or more for each $100 borrowed, and they can demand payment in full on the borrower’s next payday. However, even these states have some limits. Most of them put a limit on how much money users can borrow – either a dollar amount or a percentage of the borrower’s monthly income. Also, a federal law bars lenders in all states from charging more than a 36 percent annual percentage rate (APR) to active-duty members of the military. Many payday lenders deal with this law by refusing to make loans to service members.
• Restrictive states. In 15 states, plus Washington, DC, there are no payday loan offices at all. Some of these states have banned payday lending outright. Others have put a cap on interest rates – usually around 36 percent APR – that makes payday lending unprofitable, so all the payday loan offices have closed. However, borrowers in these states can still get loans from online payday lenders.
• Hybrid states. The remaining eight states have a medium level of regulation. Some cap the interest payday lenders can charge at a lower rate – usually around $10 for each $100 borrowed. This works out to more than 260 percent annual interest based on a two-week term, which is enough for payday lenders to make a profit. Others limit the number of loans each borrower can make in a year. And finally, some states require longer terms for loans than two weeks. For example, Colorado passed a law in 2010 requiring all loans to have a term of at least six months. As a result, most payday lenders in the state now allow borrowers to pay back loans in installments, rather than as a lump sum.
The Pew Report shows that in states with stricter laws, fewer people take out payday loans. That’s partly because stricter laws usually mean fewer payday loan stores, so people can’t just go to the nearest store for fast cash. People in restrictive states still have access to online lenders, but they’re no more likely to use them than people in permissive states.
In June 2016, the Consumer Finance Protection Bureau proposed a new rule to regulate payday lending at the national level. This rule would require lenders to check borrowers’ income, expenses, and other debts to make sure they can afford to pay back the loan. It would also limit the number of loans a borrower can take out consecutively, helping to break the cycle of debt. And finally, it would require lenders to let borrowers know before pulling money out of their bank accounts and limit the number of times they can try to withdraw money before giving up.
This rule hasn’t taken effect yet, and many payday lenders are hoping it never will. The Community Financial Services Association of America (CFSA) released a statement claiming this rule would force payday lenders out of business. This, in turn, would “cut off access to credit for millions of Americans.”
However, Pew argues that there are ways to change the rules that make it easier for low-income Americans to get the credit they need. The problem is, the proposed rule doesn’t do that. Instead, Pew says, it would let payday lenders keep charging triple- digit interest rates while making it harder for banks to offer better, cheaper alternatives. Pew has proposed its own rule that would restrict short-term loans, but would encourage longer-term loans that are easier to repay.
• Auto title loans To get around the restrictions on payday lending, some lenders offer auto title loans instead. However, this so-called alternative – which is illegal in about half the states in the country – is really just a payday loan in disguise.
When you take out an auto title loan, the lender examines your car and offers you a loan based on its value. Typically, you can get up to 40 percent of the car’s value in cash, with $1,000 being the average amount. Then you hand over the title to the car as collateral for the loan.
Car title loans have the same short terms and high interest as payday loans. Some are due in a lump sum after 30 days, while others get paid in installments over three to six months. Along with interest of 259 percent or more, these loans also include fees of up to 25 percent, which are due with your last payment.
If you can’t make this payment, you can renew the loan, just like a payday loan. In fact, the vast majority of these loans are renewals. Pew reports that a typical title loan is renewed eight times before the borrower can pay it off. So just like payday loans, auto title loans trap their users in a cycle of debt.
However, if you can’t afford to pay the loan or renew it, the lender seizes your car. Many lenders make you turn over a key or install a GPS tracker to make it easier for them to get their hands on the vehicle. Some of them even store the car while they’re waiting to sell it – and charge you a fee for the storage. And if the amount they get when they sell the car is more than what you owe them, they don’t always have to pay you the difference.
Continued next week – Part IV: Alternatives to payday loans
