A new study from the Consumer Financial Protection Bureau and a related field hearing in Nashville have put payday lending in the national spotlight, demonstrating most loans are made to borrowers who pay more in fees than they originally received in credit. As the federal regulator develops guidelines for this market, our experience in Colorado shows how the CFPB can address the problems with payday loans nationwide.
In 1992, Colorado became an early adopter of the payday loan, a new type of small loan sold as a quick fix for emergencies or unexpected expenses. While payday loans are marketed as two-week products due in full on the borrower’s next payday, the reality is most borrowers end up struggling for months to repay them. Research shows a majority of borrowers are already behind on bills, and most use the loans to cover regular expenses such as rent, credit card payments, and utilities. The lump-sum payment on the loan means that people cannot afford to repay and still meet basic expenses like rent, so three-quarters of loans are taken out soon after a previous one is paid off.
Policymakers in Colorado eventually acknowledged that the lump-sum payday loan was a failure, but they also wanted to maintain access to safer credit. So in 2010, they replaced the two-week payday loan with a six-month instalment loan. In addition to requiring more time to repay in affordable installments, the law ensures that costs are spread evenly over the life of the loan, protects borrowers’ checking accounts, and guards against excessive costs. Colorado’s new law is better for borrowers and viable for lenders, as described in a report from The Pew Charitable Trusts. Almost four years after the law took effect, access to payday credit remains widely available. Lenders still do not compete on price, but we lowered the maximum interest rate to half what it was before. Whereas the loans previously took up 38 per cent of an average borrower’s paycheque, now they take up 4 per cent. Borrowers are spending $42 million less each year, and bounced-cheque fees from lenders are down by more than half.
Scams and theft of personal information online are a danger for our residents and have led to numerous complaints here and in states with and without payday loan stores. Online lenders spend millions to lure new business, and some now offer instalment loans that are anything but consumer friendly. Lacking Colorado-type protections, they have payments that exceed borrowers’ ability to repay, carry new origination fees when loans are flipped, and lack safeguards to protect checking accounts from fraud and abuse.
States need more help combating abusive and illegal online lending, and everyone will benefit when the CFPB sets comprehensive, firm rules for payday and small installment loans alike. With clear guidelines in place, lenders and banks will compete to develop better ways to serve people in need, profitably. And any lender that violates the rules will face swift enforcement actions.
To make it happen, the CFPB should look to Colorado’s example and implement the changes needed to restore sanity to the small-loan market. Millions of people in our communities need relief from loans. In Colorado, we set strong, clear rules that have made payday loans far safer. The CFPB can and should do the same.