Each month, more than 200,000 needy U.S. households take out what's advertised as a brief loan.
Many have run out of money between paychecks. So they obtain a “payday” loan to tide them over. Problem is, such loans can often bury them in fees and debts. Their bank accounts can be closed, their cars repossessed.
The Consumer Financial Protection Bureau proposed rules Thursday to protect Americans from stumbling into what it calls a “debt trap.” At the heart of the plan is a requirement that payday lenders verify borrowers' incomes before approving a loan.
The government is seeking to set standards for a multibillion-dollar industry that has historically been regulated only at the state level.
“The idea is pretty common sense: If you lend out money, you have to first make sure that the borrower can afford to pay it back,” President Barack Obama said in a speech in Birmingham, Alabama. “But if you're making that profit by trapping hard-working Americans into a vicious cycle of debt, you've got to find a new business model.”
The payday industry warns that if the rules are enacted, many impoverished Americans would lose access to any credit. The industry says the CFPB should further study the needs of borrowers before setting additional rules.
“The bureau is looking at things through the lens of one-size-fits-all,” argued Dennis Shaul, chief executive of the Community Financial Services Association of America, a trade group for companies that offer small-dollar short-term loans or payday advances.
But that lens also reveals some troubling pictures.
Wynette Pleas of Oakland, California, says she endured a nightmare after taking out a payday loan in late 2012. A 44-year-old mother of three, including a blind son, Pleas borrowed $255 to buy groceries and pay the electricity bill.
But as a part-time nursing assistant, she worked only limited hours. Pleas told her lender she'd be unable to meet the loan's two-week deadline. The lender then tried to withdraw the repayment straight from her bank account even though Pleas lacked the funds. The result: A $35 overdraft fee and a bounced check.
After the incident was repeated five more times, Pleas said the bank closed her account.
Collection agencies began phoning Pleas and her family. About six months ago, she learned that the $255 loan had ballooned to a debt of $8,400. At that point, she faced the possibility of jail.
“It's not even worth it,” said Pleas, who is trying to rebuild her finances and her life.
Roughly 2.5 million households received a payday loan in 2013, according to an analysis of Census data by the Urban Institute, a Washington-based think tank. The number of households with such loans has surged 19 percent since 2011, even as the U.S. economy has healed from the Great Recession and hiring has steadily improved.
“These are predatory loan products,” said Greg Mills, a senior fellow at the Urban Institute. “They rely on the inability of people to pay them off to generate fees and profits for the providers.”
The rules would apply not only to payday loans but also to vehicle title loans — in which a car is used as collateral — and other forms of high-cost lending. Before extending a loan due within 45 days, lenders would have to ensure that borrowers could repay the entire debt on schedule. Incomes, borrowing history and other financial obligations would need to be checked to show that borrowers were unlikely to default or roll over the loan.
In general, there would be a 60-day “cooling off period” between loans. And lenders would have to provide “affordable repayment options.” Loans couldn't exceed $500, impose multiple finance charges or require a car as collateral.
The CFPB also proposed similar rules to regulate longer-term, high-cost loans with payback terms ranging between 45 days and six months. The proposals would cap either interest rates or repayments as a share of income.
All the rules will be reviewed by a panel of small business representatives and other stakeholders before the bureau revises the proposals for public comments and then finalizes them.
The proposals follow a 2013 CFPB analysis of payday lending. For an average $392 loan that lasts slightly more than two weeks, borrowers were paying in fees the equivalent of a 339 percent annual interest rate, according to the report.
The median borrower earned under $23,000 — beneath the poverty line for a family of four — and 80 percent of the loans were rolled over or renewed, causing the fees to further build. Over 12 months, nearly half of payday borrowers had more than 10 transactions, meaning they either had rolled over existing loans or had borrowed again.
“They end up trapping people in longer-term debt,” said Gary Kalman, executive vice president at the nonprofit Center for Responsible Lending.
Several states have tried to curb payday lending. Washington and Delaware limit how many loans a borrower can take out each year, according to a report by the Center for Responsible Lending. Arizona and Montana have capped annual interest rates.
But other states have looser oversight. In Texas, payday companies filed 1,500 complaints against borrowers to collect money between 2012 and mid-2014, according to Texas Appleseed, a social justice nonprofit.
Industry representatives say states are better able to regulate the loans, ensuring that consumers can be protected while lenders can also experiment with new products.
“We believe the states are doing a good job regulating the industry,” said Ed D'Alessio, executive director at the Financial Service Centers of America. “They come at it with a standard where the laws governing the industry have made it through the legislative process.”