Sweeping new federal rules aimed at curbing payday loans are to be released in the coming days. But backers of the crackdown say states need to remain vigilant.
The new rules proposed by the Consumer Finance Protection Bureau are expected to require lenders to verify key information from prospective borrowers, such as their income, borrowing history and whether they can afford the loan payments. The bureau released a draft of the rules last year for comment and is expected to release the final version this month.
Diane Standaert, a payday loan expert for the Center for Responsible Lending, a North Carolina advocate for reform, calls the rule “a significant first step” that recognizes the debt trap the short-term, high-interest loans can create for low-income people.
Payday loans are, as the name suggests, due on the next payday. When that time comes, the lender immediately deducts the loan and costs from the borrower’s paycheck. In many cases, these costs are so high that the borrower can’t cover all his expenses for the next two weeks. So, he turns back to the payday lender for more cash. According to the Center for Responsible Lending, it's not unusual for a $300 loan to be rolled over multiple times and ultimately cost more than $800 in principal and interest.
Despite the new regulations, Standaert and others say state policymakers should stay on guard. “We’ve seen this trend of payday lenders using the activity at the federal level as an excuse to try to persuade state legislators to weaken [their own] consumer protection laws,” she says.
Indeed, as it became clear that the feds would regulate payday lending, the industry stepped up its efforts to loosen protections at the state level. Over the past two years, more than a dozen states have been lobbied to make laws more friendly to payday lenders. All efforts have so far failed except in Mississippi, which allowed car titles to be used as collateral in certain types of short-term loans.
For instance, the payday lending company, Advance America, recently tried in Oklahoma and several other states to create a new loan category for payday loans above $500. The proposed new small loans could be up to $1,500. But instead of being due within weeks or a month, borrowers would pay them back monthly for up to 12 months -- at a 204 annual percentage rate (APR). That means a borrower could owe up to $3,600 in total payments over a year.
Payday loans are controversial, in part, because lenders typically mask interest rates. For example, the lender may give 20 percent as a rate, obscuring the fact that the rate is actually monthly. In other words, the APR is 240 percent. By comparison, credit card companies often charge an annual APR between 20 and 30 percent.
Other issues with payday lending include the additional and hard-to-understand check costs and fees charged.
While the new federal rules should help mitigate these issues, they still come with loopholes. For example, for short-term loans, the proposed rules would only kick in after six loans are made.
It's unclear how much these new rules would help in policing the practice. Research has shown that the most effective way of stopping the potential harms of payday lending is by instituting a rate cap. Rate caps can only be set by states.
At the height of the industry, 42 states and the District of Columbia allowed high interest rate loans, either through creating an interest rate cap exemption for short-term loans or through loopholes. Since 2001, however, six states and D.C. have repealed their payday lending exemptions, bringing the total to 15 states in which payday loans are now outlawed.
“The important role of the states will continue as we anticipate payday lenders continuing their aggressive push,” says Standaert.