Payday Loans and Their Not-So-Friendly Replacement

Proposed regulatory action at the federal level has payday loan lenders making drastic changes to their product lines. Many lenders are now offering payday installment loan products as well. The not-so-friendly replacement to payday cash loans extends a borrower’s repayment terms, which has the after-effect of keeping people in debt longer. While these new loans are likely to allow the short-term lending industry to remain profitable, their appearance has consumer groups and regulators worried that borrowers will remain unprotected from predatory lending practices.

Are Installment Loans an Unfavorable Replacement to Payday Loans?

The Atlantic reports that a longtime criticism of the classic payday loan platform is that it requires borrowers to repay the principal of a loan and its interest in one lump sum. This funding structure causes many borrowers to roll their cash loans over due to a lingering lack of funds, which begins a cycle of continuous debt. The occurrence of rolled over debt has been frequent enough to catch the attention of federal regulators who recently released a report detailing a list of proposed regulations.

While there are those who believe that the regulations planned by the Consumer Financial Protection Bureau, or CFPB, will tame the short-term loan industry, slightly modified products in the form of installment loan instruments are already taking the place of traditional payday advances. This proves that potentially harmful and expensive lending is likely here to stay.

The Payday Loan Industry’s Answer to Regulatory Action

The explosion of installment loans is evidence that the industry is taking the CFPB’s regulatory proposals seriously. Instead of requiring consumers to pay the borrowed funds back all at once, installment-loan borrowers pay their loans back a little at a time. While these cash loans aren’t exactly new, payday loan lenders are now making them a larger part of their business model.

The Wall Street Journal confirmed this transition in a recent article. According to the news source, last year, payday loan lenders issued approximately $25 billion in installment loan products to borrowers who had credit scores of less than 600. This figure is 78 percent higher than it was the year before.

A Pricey Way to Borrow Money

With longer repayment terms, these types of loans can be easier for borrowers to manage than payday loans. However, this type of cash loan continues to be somewhat pricey. Pew completed research on installment products, and it found that the borrowing option often features a monthly payment amount that exceeds the percent-of-income total that financial professionals recommend. Instead of being below the proposed amount, which is 5 percent, payments for these loans usually range from 7 percent to 12 percent of the recommended amount.

While the CFPB’s rules against cash loan lenders will also regulate some elements of installment loans, the focus of these rules is to protect consumers from the practices that are the most harmful. This includes giving lenders access to car titles and checking accounts.

How Do States Protect Borrowers from Predatory Lending?

Many states protect borrowers by capping the fees and interest rates that lenders are able to charge for payday loans. Some states have enacted a cap of 36 percent while others have it set higher. However, a few states have decided not to set any limits. According to the National Consumer Law Center, when lenders charge reasonable fees and rates, the interests of the borrower and the lender are aligned.

A few states have decided to protect consumers by banning the sale of add-on products and credit insurance. Along with the CFPB, states also have the power to enact regulation that requires lenders to confirm that borrowers can repay their loans. Laws that regulate the types of cash loans that operate under installment terms tend to vary when it comes to how well they cap rates. In addition, lenders have been especially adept at finding loopholes in the law for these types of loans.

Transitioning Lending Products Create a Protection Challenge

Protecting borrowers in an environment of constantly transitioning lending products will continue to be a challenge for states and government agencies. In addition, since the federal government is unable to enact interest rate limitations on lenders, interest rate caps vary significantly across the nation because this regulation is up to the states. With lenders pushing a not-so-friendly replacement to payday cash loans, it’s becoming harder than ever to protect borrowers. To read more about the changes that short-term loan lenders are making to payday loans, visit the Personal Money Store.