Industry “Best Practices” Fails to Reform Payday Loan Product
When threatened, the payday loan trade group adopts voluntary industry best practices instead of reforming their product or supporting meaningful consumer protections. Industry “best practices” do not protect consumers and do not address any of the hazardous features of loans.
Every time the payday loan industry is criticized, it updates its “best practices.” When Consumer Federation of America and US PIRG criticized “rent-a-bank” payday lending, CFSA issued best practices for partnering with banks. Those meaningless efforts did not stop the Comptroller of the Currency, the Office of Thrift Supervision and, later, the FDIC, from issuing and enforcing compliance standards that put a halt to banks aiding and abetting the evasion of state usury laws.
When witnesses in uniform began testifying in opposition to payday lending at state hearings, CFSA issued its military “best practices.” That ineffectual code did not stop the Department of Defense from calling for protections to stop payday lending to Service members or stop Congress from enacting a 36-percent annual rate cap in the John Warner National Defense Authorization Act for Fiscal Year 2007.
And, now that payday lending has been labeled “financial quicksand,” and a “debt trap” by consumer groups, civil rights organizations, military associations and financial regulators, the industry is offering an extended payment plan as another “best practice” to be adopted as legislation in some states (for more information on why “Best Practices” Don’t Work click here).
In Arkansas, in an effort to stop HB 1036 which was support by Arkansans Against Abusive Payday Lending (a coalition of 35 consumer, faith based and military groups) and would have placed a $300 fine on all loans where the interest rate exceeded the Constitutional maximum of 17% per annum, the payday lending industry offered SB 923 which offered many changes to the Check Cashers Act which were labeled “window dressing.” The industry bill did not address the main issue of the usurious triple digit interest rate and ultimately failed in the Senate with a vote of 27 for and 57 against.
Best practices are a tacit admission by the industry that their product is a debt trap. But, rather than restructuring loans to be affordable at the outset, the industry offers a once-a-year escape hatch that will not solve the problem.
Payment plans do not prevent the payday loan debt trap. The details of CFSA’s extended payment plan have not been made public, but state legislation that the industry supports illustrates why after-the-fact payment plans do not prevent payday loans from trapping unwary borrowers in a cycle of debt. Bills filed in Texas, Arizona, Washington, Colorado, and Arkansas require a borrower to request, sometimes in writing, an extended payment plan the day BEFORE the loan is due in order to be eligible for more time to pay. Only one plan per year is offered by the industry, although the average borrower has eight or more loans during the year (for more information on why Repayment Plans Don’t Work click here).
Repayment plans already in state laws are optional, not required, and are seldom used due to obstacles and lender incentives to discourage use of the plans. States with these laws include Alabama, Alaska, Arkansas, Florida, Illinois, Michigan, Nevada, Oklahoma and Washington. Less than half of one percent of loans in Oklahoma are paid through an extended payment plan while the average Oklahoma borrower has nine loans per year. In Washington, 90 percent of loans go to borrowers with five or more loans per year, borrowers’ average eight loans per year, and less than 0.8 percent of loans employ the payment plan option.1
To ensure that states are aware of what their lenders are doing and how consumers use payday loans some well meaning states require licensed lenders to report loan transactions to a central database that must be consulted by lenders in making loans. States that require databases are Florida, Oklahoma, Indiana, North Dakota, Michigan, Illinois and Alabama. While these databases sound good in theory, they don’t work out as planned (for more information on why State Databases Don’t Work click here and why Databases Don’t Address the Debt Trap click here).
Payday loans were sold to state legislators as “once-in-a-blue-moon” emergency cash flow tools. The reality that has emerged is that payday loans foster repeat borrowing and become long term or frequent obligations. A Texas study found that the average borrower had 9.8 loans per year, indicating that payday loan behavior is unlikely to be driven by temporary shocks to consumption needs. In contrast to industry claims that payday loans are only used to cover emergencies such as car repair or doctor visits.
A loan is “rolled over” when a payday loan is extended for another pay cycle before the loan is again due. The lender collects the finance charge, but the loan principal is not reduced. Some states, like Arkansas, ban rollovers, but that is easily circumvented. Lenders can allow borrowers to pay off one loan and immediately take out another one, sometimes called back-to-back transactions or serial loans (for more information on why Bans on Rollovers Aren’t Stopping Them click here).
Payday loans are a flawed financial product. From the triple digit interest rates, to the balloon payment where the loan is due in full on the borrowers next payday. This product has been designed by the industry to make it next to impossible for the borrower to payoff the loan when due (in 14-days) and not have to borrow again. Instead, because the loan product was not designed to have a reasonable interest rate and installment payments so over time the borrower could repay the loan with reasonable payments and interest costs, the borrower get caught up in a debt trap of rolling over the loan payday after payday with no end in sight.
1“Protecting Working Families from Abusive Payday Loans: Lessons from Other States,” VaPERL, January 2007,