Payday Lenders Hit by New Regulations

In June, Congress overturned a set of regulations enacted in late 2020 by the Office of the Comptroller of Currency (OCC). The nullified rules, which have been signed off by President Biden, end a payday lender practice that was referred to as a “rent-a-bank” scheme. The rule stated that to be considered a lender, a national bank or federal savings association had to either be named as the lender in the loan agreement, or fund the loan. While some states cap loan interest rates, the former enabled lenders to bypass state limits by partnering with a national bank (which are not subject to state usury laws). In short, the former rule would allow a lender to make high-cost installment loans.¹

A payday loan is generally issued for a small amount, typically $500 or less. The idea is that the borrower can repay the loan when he receives his next paycheck. However, it is a high-cost loan, typically $15 for every $100 borrowed. According to the Consumer Financial Protection Bureau, that comes to about a 391% APR for a two-week loan. Because the loan increases exponentially, the borrower may not be able to pay it off in two weeks, after which it rolls over and accrues even more interest.²

This is one reason so many financial professionals recommend that every household maintain an emergency savings fund of at least three to six months expenses. In some cases, this goal can be accomplished in conjunction with a life insurance policy that includes a cash account. If you’d like to learn more about insurance paired with savings options, please give us a call.

The payday business model basically relies on repeat borrowing. About 75% of payday loans go to people who take out 11 or more loans per year.³ According to Pew Charitable Trusts, the average borrower pays as much as $520 in fees for a $375 loan. That’s why most states cap payday lending to amounts ranging from $300 to $1,000.⁴

At present, there are 18 states and Washington, D.C., that have passed laws capping short-term loan rates at 36% or less, with other states currently considering similar legislation. Pew Charitable Trusts reports that states that ban or limit this practice have no storefronts.⁵

However, payday loans are increasingly being offered via deceptive and illegal means via the internet. According to the FTC, fraudsters contact consumers with claims that they owe “phantom” payday loan debts.⁶ The borrower may think he still owes money on a loan taken out in the past that, in fact, he already paid back.

Unfortunately, for many people, borrowing from a payday lender is the only way to get cash quickly. Each year, approximately 2.5 million American households take out one of these types of loans — largely because they don’t have other financing options. With poor credit or no income, they may not qualify for a credit card or a personal loan with better terms.⁷ In fact, about 42% of millennials have used this type of loan.⁸ The worst part is that payday loans create a debt cycle that ends up keeping people out of the financial system that could help them build a positive credit history.

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¹ Ken Sweet. The Seattle Times. June 25, 2021. “Congress repeals Trump-era regulations on payday lenders.” https://www.seattletimes.com/business/congress-repeals-trump-era-regulations-on-payday-lenders/. Accessed July 12, 2021.

² Jackie Veling. NerdWallet. April 26, 2021. “What Is a Payday Loan?” https://www.nerdwallet.com/article/loans/personal-loans/what-is-a-payday-loan. Accessed July 12, 2021.

³ Catherine Treme. Yahoo! Finance. July 7, 2021. “Why Payday Loans Are Dangerous.” https://finance.yahoo.com/news/why-payday-loans-dangerous-180034752.html. Accessed July 12, 2021.

⁴ Jackie Veling. NerdWallet. April 26, 2021. “What Is a Payday Loan?” https://www.nerdwallet.com/article/loans/personal-loans/what-is-a-payday-loan. Accessed July 12, 2021.

⁵ Annie Millerbernd. The Detroit News. July 7, 2021. “Are state interest-rate caps an automatic win for borrowers?” https://www.detroitnews.com/story/business/personal-finance/2021/07/12/state-interest-rate-caps-automatic-win-borrowers/7913269002/. Accessed July 12, 2021.

⁶ Federal Trade Commission. 2021. “Payday Lending.” https://www.ftc.gov/news-events/media-resources/consumer-finance/payday-lending. Accessed July 12, 2021.

⁷ Ben Luthi. Experian. January 3, 2019. “What Is a Payday Loan and How Does It Work?” https://www.experian.com/blogs/ask-experian/how-payday-loans-work/. Accessed July 12, 2021.

⁸ Catherine Treme. Yahoo! Finance. July 7, 2021. “Why Payday Loans Are Dangerous.” https://finance.yahoo.com/news/why-payday-loans-dangerous-180034752.html. Accessed July 12, 2021.

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