Payday loans have long been huge financial traps for cash-strapped, low-income borrowers.
Several states have tightened regulations to clamp down on these quick-fix loans, which sometimes carry annual interest rates of 400 percent or more. But a lot more needs to be done, particularly because the federal Consumer Financial Protection Bureau has not yet formulated rules governing these loans.
A new study by the Center for Responsible Lending, a nonpartisan research group, has found that the payday loans cost American families $3.4 billion in fees every year. Despite state efforts, millions of borrowers remain at the mercy of unscrupulous practices.
Payday loans — which can come from banks, storefronts or online services — are billed as short-term credit options, but they actually force people into a debt cycle. Borrowers often do not have enough income to repay the loan and cover recurring monthly expenses, so they have to borrow again and again.
This trap is built into the business model.
For example, an analysis earlier this year by the Consumer Financial Protection Bureau found that three-fourths of payday loan fees were generated from people who borrowed more than 10 times in a 12-month period.
Payday lending expanded dramatically during the 1990s, when many states unwisely exempted the lenders from usury caps.
But after seeing borrowers being destroyed by these loans, many states, according to the study, have in recent years either prohibited payday lending or put new limits on it.
For example, voters in Arizona and Montana voted to bring payday lenders under a 36 percent interest limit. Voters in Ohio defeated a ballot initiative that would have overturned the state’s 28 percent rate cap. Delaware and Washington state have limited the number of payday loans that a borrower can take in a single year.
Still, more than half the states offer little or no protection from unscrupulous payday lenders.
The Consumer Financial Protection Bureau is barred by law from setting interest rates. But it can do more. It could help vulnerable, low-income borrowers by putting an end to deceptive advertising and balloon payments that make it impossible for borrowers to close out a loan.
It could also force lenders to verify the borrower’s ability to repay before a loan is made.