Convenient short term loans remain a target of financial reform

A frustrated consumer with his credit card bill

The financial reform bill doesn’t directly regulate payday lenders and their customers, but a consumer agency created by the bill could impose restrictions that limit access to short term credit. Flickr photo.

Payday lenders and their customers escaped regulation during the latest round of financial reform in Congress. But the payday loan as a financial reform issue isn’t going to go away. A payday loan amendment regulating the industry failed to make the financial reform bill. But a provision creating a consumer protection agency did. This consumer protection agency can regulate the payday loan industry.

Payday loan regulation is coming

Payday lenders and customers should be concerned about what may happen when the financial reform bill is ultimately passed. It includes the creation of a new Consumer Financial Protection Agency (CFPA) that will have rule-making authority and oversight of payday lenders. It could impose restrictions on payday lenders that could drive them out of business and remove access to convenient short term credit for consumers. The Michigan Messenger reports that language in both the House and Senate versions of the bill ensure that the CFPA has oversight and rule-making authority over all payday lenders. The CFPA will enforce rules against bigger lenders and the Federal Trade Commission will enforce rules against smaller lenders.

Payday interest rates misconstrued

No interest-rate or rollover caps for online payday loans with instant decision are present in either the Senate or House versions of the financial reform bill. However, the CFPA could end up considering a provision promoted by Illinois Democratic Senator Dick Durbin for capping the maximum annualized percentage rate of interest a payday lender could charge on most credit check loans at 36 percent. While a 36 percent interest rate would seem unusually high for a car loan or a mortgage loan lasting many years, it’s not enough to support small, short term loans lasting two weeks.

Cheap payday loans endangered

Direct payday lenders would not be able to make credit available to their customers if they offered 36 percent APR. The Richmond Times Dispatch reports that at 36 percent APR, the total fee charged on a $100, two-week cash advance would be $1.38. At that rate, payday advance lenders could not cover the cost of originating the instant payday loans, let alone meeting employee payroll and benefits and other fixed business expenses, like rent.

Payday loan alternatives are scarce

If payday lenders were forced out of business by regulations such as the 36 percent interest rate cap, consumers who need online loans for unexpected expenses would have few alternatives. The fees banks charge can make borrowing from them more expensive than getting payday loans. In fact, a study by Victor Stango, Ph.D., Associate Professor of Management at University of California, Davis, shows that that credit unions cannot offer payday loan alternatives any more cheaply than payday loan companies.

Credit unions can’t compete

The fees and convenience of payday loans were compared to credit union short-term loans in Stango’s study. His research, compiled from credit union data, the National Credit Union Administration and payday loan customer surveys, found that credit union rates are generally equal to or higher than those of traditional payday lenders, and the loans are less convenient for borrowers. Credit unions also weren’t able to compete with payday lenders on important things such as hours of operation or protection against damage to a borrower’s credit score from default.

Do payday lenders protect consumer credit?

Without payday lending, convenient access to short term credit would be scarce. Stango’s study said fewer than 6 percent of credit unions offer payday loans because most see little chance to make money on a competitively priced payday cash advance product. Plus, credit union payday loans often have total fee/interest charges that are equal to or higher than standard payday loan fees. Furthermore, application times are longer at credit unions, and default on a credit union payday loan may harm a borrower’s credit score, while default on a standard payday loan usually does not.

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