Payday Lending Reform and the Need to Reduce Demand

Here in Colorado we had an initiative on the ballot last week to restrict payday loans to a 36% APR cap. It passed overwhelmingly because the general public does not want to support lenders who charge triple digit rates. The law goes into effect on February 1 and it likely means the end of the payday lending industry in Colorado.

This change comes on the heels of an opposite move at the federal level where the CFPB said it plans to propose revisions to existing rules that were designed to reign in payday lenders nationally. The CFPB had spent six years doing research and decided that one way to make payday lending more responsible was to require a check on a borrower’s ability to pay. It makes sense as this is what pretty much all other types of personal loans require.

But the payday loan industry has become successful in part because lenders did not have to take into account a borrower’s ability to repay. By not having to do this important step lenders could save money and expand their borrower base. But in doing so they have been serving many people for whom a payday loan is clearly a bad idea.

I have no problem with payday loans at all, they have a place in emergency funding for people who don’t have any savings. What I abhor, though, is predatory lending. This is when the payday loan becomes a debt spiral as the loan is continuously rolled over and a manageable $500 loan becomes a $2,000 or $3,000 nightmare that the consumer cannot pay back.

While I support the Colorado measure in theory it is a very blunt instrument to take to a difficult and nuanced problem. Saying that a 36% APR is a hard cut off for any kind of loan is a little short sighted. Let’s take an example of a $500 loan with a $25 fee (an unusually low fee) that is paid back in 30 days. This loan would represent a 60.83% APR, way above the 36% APR threshold that will become law in Colorado on February 1, 2019. I don’t think any reasonable person could argue that a $25 fee for a $500 loan is predatory. The reality is that APR is just a very poor measure to use when it comes to short term loans.

One of the largest banks in America, U.S. Bank, recently announced they were getting back into the short term loan business. Called Simple Loan, this product is a three month loan of up to $1,000 and is designed to compete with payday lenders. They provide an example on their website of a $400 loan that carries a fee of $48 with $448 being paid back in three months which equates to an APR of 70.65%. This loan will also become unavailable to Colorado consumers next year.

Supporters of the measure argue that taking away a payday loan option will mean fewer consumers will get into financial hardship. But it doesn’t address the root cause of the problem and the fact that people have to turn somewhere when a financial emergency arises.

We Need Initiatives to Drive Away Demand for Payday Loans

One of the frustrating things to me is that everyone talks about how bad payday loans are but few people talk about how to keep consumers from needing them. This comes down to improving financial health. This is becoming an ever more important topic in fintech as many companies are bringing financial health into the forefront of their thinking. Consumers have more tools than ever before to really help get their financial houses in order.

I feel that we are on the cusp of a sea change where simple app-based tools will be able to help us manage our financial lives. We already have multiple companies out there addressing overdrafts, late payment fees, savings and budgeting. Not to mention all the education that is available today. What we need is for those people suffering financial stress to use the tools that are available today.

New research from the Center for Financial Services Innovation (CFSI) shows that 28% of Americans are financially healthy and 36% are unable to pay all their bills on time. It is this 36% that desperately need responsible alternatives. What I am hoping for is some fintech companies focused on financial health to really break out nationally in the near future. There are signs that this is starting to happen.

It is only when consumers know they have good alternatives will demand for payday lending subside. I don’t think regulation is the way to attack this problem although rules should be created to make predatory lending impossible. It will be interesting to see what happens in Colorado as this new rule goes into affect. But I live in hope that one day soon we can reduce demand for payday loans because there will be so many nationally well known alternatives.