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  • Chloe Lau, UC Berkeley Policy Intern

Payday Lending Reform Could Pave Ways to More Prosperity for All

Nearly one in four Americans has no emergency savings at all. Given this dire reality, more and more households are turning toward a risky short-term option to make ends meet: the payday loan.

Almost uniformly derided by personal finance experts, a payday loan usually consists of a few hundred dollars which anyone with a valid ID and proof of income qualifies for, provided that they agree to pay it back when their next paycheck arrives in two weeks. However, such a loan differs from a traditional bank loan in that it comes with an extremely high annual percentage rate (APR)—an average of 400% across the United States. Unsurprisingly, most borrowers are unable to repay their loan within two weeks, which means that they have to re-borrow the loan and face a growing debt.

Pew Charitable Trust estimates that it takes borrowers an average of five months to pay off a payday loan, and they end up paying an average of $520 in charges on top of the initial amount of the loan. Thus, what appeared to be a quick fix to unforeseen expenses such as injury or unemployment can quickly spiral a household into debt as borrowers scramble to pay off a much larger sum of money than they took out in the first place.

As the payday loan industry expands, researchers have explored who uses them and why. The use of these loans coincides with the decades-long trend of stagnating wages that has left many Americans without sufficient buying power. The people who rely most on these loans are predominantly low-income households who encounter a “short-term financial setback or emergency and don’t have access to a traditional form of credit,” as Danielle Snydor from the NAACP of Cleveland puts it. For example, when a low-income family’s car breaks down, they must put all their earnings toward repairs, and then find a way to cover rent for the month, which makes the one-time instant cash a payday loan offers appear to be relatively attractive.

Notably, millennials are among the most frequent borrowers of payday loans, as they carry an enormous amount of student debt while facing fewer options for stable employment and benefits like health insurance. As of 2019, one in three millennials has considered taking out a payday loan, despite being aware of the high interest and fees. Morning Consult conducted a survey which found that around 21% of people who take out payday loans are classified as millennials (ages 18-21) or Generation Z (ages 22-37). Especially given that most of these individuals have no assets and will not qualify for traditional bank loans, payday loans may seem like the only option when faced with immediate and mounting bills for tuition and student loan payments.

Given the debt trap that payday lending currently poses to consumers, it is crucial to strengthen protection for borrowers and to regulate the short-term loan industry. However, the Consumer Financial Protection Bureau (CFPB) operating under the Trump administration announced its intention to roll back Obama-era protections in February. These protections included capping interest rates on certain loans and requiring that lenders determine borrowers’ ability to repay their loans before issuing them.

With these federal rollbacks taking place, states like California can still take measures to protect consumers. Within California, nearly 2 million people use a payday loan every year. These borrowers are already among the most likely to have debt, with most having an average annual income of $10,000 to $40,000. Payday lenders increasingly tend to concentrate in low-income areas, making these consumers most vulnerable. California is among those states with extremely high interest rates on loans—the average APR for a payday loan last year was 377%, more than the previous year. Attempts have already been made to regulate the industry, but key legislative bills that were introduced to do so, such as AB 2953 and SB 515 have either stalled or died. These bills would have capped interest rates at 36% and extended the minimum length of a loan so that borrowers would have had a higher chance of repaying their loans on time. Experts report that payday lenders continually lobby legislators to defeat bills like these, as they maximize their profits when people fail to repay their original loan and must re-borrow. Licensed lenders collected a total of $436.4 million in fees last year, the majority of which came from people who re-borrowed at least seven times.

Perhaps California can look to states like Ohio, which Pew Charitable Trust cites as a model for regulating payday loans at the state level. After years of widespread public demands for expanded consumer protection, a bipartisan coalition of both House and Senate representatives authored HB 123, the Fairness in Lending Act which, among other things, caps the interest rate and limits monthly loan payments under 90 days to 6% of monthly income. As a result of these protections, Ohio has saved families nearly $75 million per year that they would have paid in fees, while also making it safer, and thereby, more desirable to participate in the short-term loan market, which keeps lenders in the state. If California’s legislators can find a way to strike this balance between consumers’ and lenders’ interests, they may pave the way to more prosperity for all.

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