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Pamela Foohey, expert on bankruptcy and consumer law
What role should the federal government play in regulating alternative lending? According to a 2011 survey by the Federal Deposit Insurance Corp., more than one in four households in the U.S. are “unbanked” or “underbanked,” which means a very large segment of Americans who have low credit scores or live in low-income or rural areas are forced to rely on alternative lenders such as payday loan companies for credit.
Pamela Foohey is a law professor whose research focuses on bankruptcy, commercial law and consumer law. She spoke with News Bureau business and law editor Phil Ciciora about reforming payday lending practices.
The Consumer Financial Protection Bureau recently issued a new study finding that more than 80 percent of payday loans are effectively renewed or combined with another loan within 14 days of paying off the previous loan. What does that suggest? Should there be a legislated “cooling-off” period for payday loans?
The finding relies on a broader definition of rollover than simply those that are renewed on the same day they are due. The 80 percent figure includes those loans that are followed by another loan within 14 days – that is, renewed within 14 days. The definition reflects the fact that some states have mandatory cooling-off periods already, such as Alabama’s law that specifies that borrowers must wait until the next business day to take out a loan after two consecutive loans are paid in full and Florida’s 24-hour cooling-off period after each loan.
This suggests that people are not using payday loans as short-term credit, but rather are using them like more traditional credit products, such as credit cards. However, payday and similar types of alternative lending carry extremely high interest rates and fees. The result, for example, is that a customer who takes out a $400 loan and rolls it over repeatedly may pay $500 in interest and fees.
Instituting cooling-off periods that are longer than merely a few days or capping how many times a borrower may take out or roll over a loan in a given period, such as a year, could help curb some of the marketing techniques that payday lenders have been known to use to convince customers to roll over or take out effectively consecutive loans. Limiting rollovers may decrease the high interest that customers end up paying on payday loans when they use them as they do now.
In addition, payday loan customers sometimes borrow from more than one loan provider. Any cooling-off period or cap on rollovers must limit the universe of loans a customer may take out, not merely the timing and number of loans a customer may receive from a single provider.
However, cooling-off periods are a second best solution to one of the main problems with payday loans: the high annual percentage rates. Legislation that caps the APR on payday loans – and all payday loan-like products – is a more effective solution, though probably less likely to be passed by legislatures.
A recent idea that has gathered steam is replacing payday lenders with the U.S. Postal Service. Essentially, the Postal Service would partner with banks to perform the same functions as a payday loan company but at much better rates for the economically vulnerable. Plus, the Postal Service usually has a physical office in so-called “bank deserts.” Is that a viable option?
The idea of the federal government partnering with banks or credit unions to offer loans through U.S. Postal Service locations is an innovative and possibly viable idea.
Millions of Americans live in rural, isolated areas or in low-income areas that banks increasingly are moving out of, partially because of the low credit scores of these areas’ residents. These people have diminished access to credit, providing payday and similar lenders with a captive market. But there are post offices in all of these areas. Utilizing these physical locations to bring more mainstream credit options to all Americans has the potential to reduce the reliance of the underbanked and the underserved on high-cost alternative lending products. The question, of course, is exactly how the partnership between the U.S. Postal Service and banks or credit unions would work.
Beyond relation and using the physical location of postal offices to bring more mainstream credit to people, the underlying issue is that individuals and families who turn to alternative lending often simply do not make enough money and thus are not able to save money to use during periods of unemployment or when unexpected expenses arise.
Ultimately, I think that many Americans turn to alternative lending because they are living paycheck to paycheck, which itself is linked to issues such as income inequality, the minimum wage and unemployment insurance, all of which are issues that also have been receiving substantial media attention recently.
Online lending is seemingly the next horizon for short-term credit products. What needs to be done to take into account both the financial situations of borrowers and what we know about how non-bank financial services operate?
Indeed, online lending does seem to be the next horizon for short-term credit products. Without the need for any physical location, lenders can reach even more people. And lenders can be located anywhere, which necessitates federal legislation.
As to the exact legislation, besides interest rate caps, clear disclosure requirements may be particularly important in this area. For instance, studies have shown that people who take out payday loans often do not know the interest rate on the loan or cannot calculate the APR. There is a lack of information – and some incorrect information – among borrowers about these loans. If these loans are marketed and sold online, misinformation and lack of information may be exacerbated.
Online lending also may make it easier for people to take money out online because they do not have to go to a brick-and-mortar location, which takes both physical and mental energy. Nonetheless, studies suggest that people who take out payday loans on average do so because they need the money to pay their daily expenses. Payday and alternative loans are serving an underserved market. Regulation can help make the loans safe and affordable.
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