Predatory Lending And Fixing The Small Loan Market

Elliott Clark couldn’t keep up with his family’s bills when his wife broke her ankle and couldn’t work. So he did what an estimated twelve million Americans do each year-- he took out a payday loan. A payday loan is typically a small dollar, short-term loan advertised as a quick, convenient solution to life’s unexpected problems. Clark’s story made headlines in Kansas City, MO where it was reported that over the span of five years, Clark spent $50,000 interest on five $500 payday loans. The typical annualized percentage rate (APR) of interest on a payday loan in Missouri is 450 percent.

Surely paying $50,000 on $2,500 in payday loans must be unheard of? It must be illegal? Unfortunately, in many states, high cost payday loans are legal and all too common. Indeed, a recent Lifeway Research survey of Christians in the thirty states without significant regulation of small dollar loans found that 17 percent of Christians had taken out a payday loan.

The Injustice of Payday Loans

Throughout much of our nation’s history, states maintained usury or small loan laws that capped the interest rates on small dollar loans at about 36 percent APR. But starting in the 1980s and 1990s, many state legislatures amended these laws, enabling the emerging payday loan industry to charge much more than 36 percent interest by styling their charges as fees on a short-term loan. In Elliot Clark’s home state of Missouri, state law permits lenders to charge 75 percent of the principal borrowed on a loan due within a month or less. In annualized terms, means triple digit interest on small, short-term loans. Today, fewer than twenty states’ laws meaningfully regulate high-cost payday loans.

In Missouri, as in other states that permit high-cost payday lending, the majority of payday loans are made to borrowers who find themselves in a debt trap, taking out not just one short-term loan but multiple loans as they attempt to keep up with the loan and all other expenses. As borrowers take out loan after loan or, in some cases, refinance or “flip” a single loan, their costs quickly snowball. When clergy and faith-based service providers were surveyed about the impact of high-cost payday lending, many noted that the costs extended beyond the financial. Faith leaders and borrowers reported familial stress, anxiety, increased need for emergency assistance, and shame as common among households with payday loans.

Loans that entrap borrowers in a snowballing cycle of debt are not just a personal problem but an affront to public justice. Credit has an important function in our economy. Payday lending distorts this function, converting a valuable institution into a predatory one. Used properly, credit covers the gaps in time between expenses and income. But payday lenders routinely extend credit to customers without regard for borrowers’ projected income and expenses. As a result, many payday loans are extended to individuals who are struggling not with a gap between present expenses and future income, but between total expenses and total income. A high-cost payday loan doesn’t alleviate this problem; it just adds to it.

That many payday loans result in a debt trap is no surprise to the payday loan industry. Indeed, the training manual of one major company provided its employees with instruction on exactly how to encourage cyclical, repeat borrowing. Payday lenders also typically demand, in exchange for a loan, a post-dated check, a car title, or access to the borrowers’ bank account as collateral. This motivates borrowers to keep paying on their payday loans even when they cannot pay other bills. Writing for  Capital Commentarylast year, Stephen Reeves describes how far payday lending deviates from just lending,

These products are not loans in any traditional sense; they are self-perpetuating, fee-generating devices whose structure creates a perverse profit incentive for borrower failure. The more the borrower fails, the more money the lender makes...Industry members justify their products by pointing to the high demand for such loans. While certainly some people need small-dollar loans at times, no one needs a 500 percent interest rate.

To double the injustice, many of those who take out payday loans are poor or near-poor. The median payday borrower reports an annual income under $23,000. A quarter of loans are extended to individuals receiving public assistance or retirement funds. For Christians called to defend the rights of the poor, the prevalence of high-cost payday loans is a deep cause for concern. As Reeves remarks, “There have always been and always will be people desperate for money. The question is what we as a society do about those willing to exploit that desperation for profit.”

So what are we willing to do about it?

Restoring Just Credit: The Role of Government

When payday lenders proliferate in under-regulated communities, as they now do (payday loan stores outnumber Starbucks and McDonalds) and so thoroughly exploit their own customers, government has a necessary role in re-righting the relationship between individuals and this part of the credit market. The Center for Public Justice’s latest book, Unleashing Opportunity: Why Escaping Poverty Requires a Shared Vision of Justicerecently discussed the problem of high-cost payday lending and the role of government in ensuring a just market:

One might argue that the free market exists to offer ready alternatives for a moment like this. But that’s less than half of what should be said. Christian philosophers and economists have long argued that free markets are to be just markets. Within just markets, businesses rightly uphold their responsibilities as they seek to satisfy legitimate human needs and contribute to human flourishing as they profit.

In 2011, Elliot Clark, a member of Kansas City’s St. Therese Little Flower parish, along with thousands of other people of faith and pastors, priests, and rabbis called upon their state government to rein in predatory payday lenders. They promoted legislation and, then, a statewide ballot measure intended to cap the rates on payday loans at 36 percent APR. Although their proposals never received a popular vote, Clark and his community kept advocating. Faith communities in many other states have done the same.  

In 2015, many national religious institutions (including the Center for Public Justice) formed the Faith for Just Lending coalition to call for an end to predatory payday lending. Faith for Just Lending emphasizes the need for better laws as well as the responsibilities held by individuals, congregations, and businesses to prevent and respond justly to financial emergencies.  
Last week, the Consumer Financial Protection Bureau proposed new federal rules designed to curtail debt-trap lending in the payday loan market. The Consumer Financial Protection Bureau (CFPB) serves as a watchdog over the numerous and increasingly complex financial products that Americans use. In 2010, Congress created the CFPB and empowered the agency to oversee and regulate payday loans. In choosing to propose new rules on payday, the agency’s director specifically noted the witness of the faith community

Perhaps most telling of all, we have held numerous sessions with a broad set of faith leaders. They have shared searing experiences of how payday loans affect the people they care for every day in their churches and synagogues and mosques. And they have described how these loans undermine financial life in their communities. In devising this proposed rule, we have been listening carefully, and we will continue to listen and learn from those who would be most affected by it.

The CFPB’s proposal marks a positive step toward ending debt trap lending. The proposed rule requires payday and car title lenders to determine whether a prospective borrower can repay their loan on time while also keeping up with other expenses. This common sense requirement gets to the heart of what goes wrong with so many payday loans. It restores lenders’ incentive to lend to borrowers who can repay (and on terms that borrowers can repay) rather than profit when borrowers flounder.

Fixing the payday loan market is complex. Many  payday reform advocates worry that the same unscrupulous companies that worked loopholes into state laws will exploit weaknesses in the federal rule. To further complicate the task, the legal powers needed to fully rein in the most unscrupulous of lenders are divided among different parts of government. Although the CFPB can address underwriting and re-borrowing, it cannot regulate interest rates. Only state legislatures and Congress can. Yet, an inclusive cap on interest and fees is one of the simplest ways to discourage predatory lending and limit loopholes. 

The CFPB’s efforts to rein in high-cost payday loans also demonstrates the challenge of regulating businesses that aggressively flout their basic responsibilities. The payday industry’s track record indicates an intent not to deal fairly with their customers but to make a profit from them at any cost. But that does not mean that we should throw up our hands and allow these businesses to continue to exploit the vulnerable. There is much we can do.

Restoring Just Credit: The Role of Other Institutions

First, we can recognize the multiple institutions that play a part in restoring justice to the market. Among them are other businesses. For example, Google recently took the initiative to ban payday ads on its site. Google’s new policy, which takes effect in July, allows paid ads to appear only for lenders who offer loans at 36 percent APR or less and allow at least sixty days for repayment.

Similarly, churches and nonprofits can continue model good stewardship and offer aid to financially struggling households. The Chalmers Center’s Faith and Finances program provides churches with a curriculum to equip low-income participants with financial education and biblical principles of stewardship.  In Minneapolis, Minnesota, Holy Trinity Lutheran Church started Exodus Lending in response to predatory lending in the community. To help borrowers trapped in debt, Exodus Lending refinances their loans and offers new loans at a reasonable interest rate. Exodus Lending also provides financial counseling and helps clients set up a savings account.

Second, we can persist in our advocacy. When the CFPB announced its new rules last week, it did so at an event in Kansas City. Elliot Clark was there. Hundreds of his fellow citizens from Kansas City and clergy from across Missouri were there too. They had lost a ballot measure but their stories reached national policy makers at the CFPB. Sustained and committed advocacy can make a difference.

Now the next phase of advocacy is beginning. The CFPB is seeking public comments on its proposed rules between now and September. Comments that testify to the need for payday lending reform and call for fewer loopholes can encourage the agency to make its final rule as effective as possible. Following the comment period, the agency will finalize and begin enforcing the rules. Advocates will then need to attend to state legislatures and to Congress, encouraging them to use their authority to rein in exorbitant interest rates and limit loopholes.  

Restoring Just Credit: The Road Ahead

There will always be a need for fair credit. Households will continue need to bridge gaps between current needs and future income. Meaningful regulation by the CFPB, states, and Congress can help weed out businesses that rely on unethical business models and exorbitant rates of interest. Meanwhile, businesses have a responsibility to design and offer credit on affordable terms to lower income customers. Some credit unions that have long served low-income communities have designed small dollar credit with fair pricing. Other innovations are on the horizon such as a Texas partnership between employers and a community loan fund

Regulating payday lending will not alleviate the gap between needs and income that predatory lenders have so successfully exploited. For these households, restoration also means addressing the conditions of poverty and lack of opportunity. This too, is a task for the faith community and a deeply complex one at that. But protecting households from debt traps that exacerbate the effects of poverty is certainly a start.

- Rachel Anderson is a Fellow at the Center for Public Justice. She is an attorney and founder of the Faith & Credit Program at the Center for Responsible Lending.

-Katie Thompson is the editor of Shared Justice, an online publication for millennials published by the Center for Public Justice. She is a co-author of Unleashing Opportunity: Why Escaping Poverty Requires a Shared Vision of Justice.