Right now, 12 million Americans are caught up in a cycle of loans that boast interest rates of 400 percent or more. Borrowers will spend an average of 212 days out of the year repaying these loans, and the average borrower spends more than $1,105 to pay off a loan of just $305, according to the Center for Responsible Lending.
Welcome to the payday lending industry, a booming business with more than 22,000 locations throughout the U.S., which generates about $27 billion in annual loan volume and more than $3.5 billion in accrued fees alone, each year.
According to Investopedia, payday loans are defined as a type of short-term borrowing whereby an individual “borrows a small amount at a very high rate of interest.” In general, these kinds of loans are used to help get folks through rough patches, especially when unexpected expenses crop up.
Say you’re living paycheck to paycheck and you’re coming up on the first of the month. Rent is due, but maybe, over the past month, you had to go to the hospital, resulting in unexpected medical bills you otherwise wouldn’t have had. What are you going to do? Payday loans market themselves as a quick and easy fix to such unforeseen financial hardships, and are known for preying on working class families.
How do they work?
In general, payday loans have three key features, according to the Consumer Finance Protection Bureau. For one, these loans are typically for small amounts (generally $500 or less). They are most often due on your next payday (say, two weeks from the date you borrow), and, in general, you must give your lenders access to your checking account or write a check in advance for the full amount which the lender can then deposit when the loan comes due.
Here’s the catch, though. Because the interest rates and fees on these loans (even though they’re for a short period of time for a small amount), most people are unable to pay the full amount of the loan back on time. This is the lifeblood of the payday lender, and they count on your inability to pay in full; eventually, most borrowers end up caught in a vicious cycle of “recycled debt.”
The payday lending industry survives and thrives off repeat customers. The Center for Responsible Lending notes that, “90 percent of the payday lending business is generated by borrowers with five or more loans a year.” Even more astoundingly, “60 percent of business is generated by borrowers with 12 or more loans per year.”
Annual interest rates for these kinds of loans, as we noted earlier, are astronomical; the average annual interest rate for a payday loan, according to the Center for Responsible Lending, is more than 400 percent. Compare that to APRs on your average credit card, which range from 12 to 30 percent; in other words, payday loans offer an interest rate that is between 13 and 33 times higher than your average credit card.
Perhaps the worst injustice of the payday loan industry is the fact that it is designed to prey upon the poorest Americans. Payday loan stores are strategically placed in low-income neighborhoods, and in fact, nationally, there are more than two payday loan storefronts for every Starbucks.
Currently, the Center for Responsible Lending reports that seventeen states, as well as the District of Columbia, have enacted double-digit rate caps on payday loans, limiting these lenders to an interest rate of 36 percent or lower.
Paheadra Robinson, Director of Consumer Protection at the Mississippi Center for Justice, which is currently working to establish a double-digit cap of 36 percent and a longer re-payment period for payday loan borrowers, notes that far from being “leaches on the system,” often times the individuals most susceptible to the “recycled debt” of a payday loan scheme are single parents; 60 percent of payday loan borrowers in Mississippi are women, for instance. She also notes that in Mississippi, which continually ranks among the poorest states in the U.S., there are more payday loan stores than there are McDonald’s, Burger King, or Wendy’s stores combined.
Veterans and military personnel make up another group which is often preyed upon by payday lenders; the Consumer Finance Protection Bureau notes that the Military Lending Act (MLA), which was first enacted in 2007, has made it illegal for an active duty guard or service member to be charge an interest rate higher than 36 percent, in any state; the law also protects the spouse and dependents of service members and prohibits payday lenders from “rolling over” or re-financing the same loan. Many consumer advocates, such as the Consumer Federation of America, have recommended expanding the act to include all Americans as one solution to the devastation often caused by these lenders.
Other measures to curb payday lending and other forms of predatory lending include establishing local ordinances to ban payday lending entirely, as well as measures to establish similar small-loan services through credit unions or community organizations which emphasize educating borrowers on how they can begin saving and budgeting more effectively.
In general, however, payday lending lobbyists (which often call themselves by more euphemistic names, such as the “Community Financial Services Association”) have made measures to curb the payday lending through legislation exceedingly difficult. In July, however, two U.S. representatives, Steven Cohen of Tennessee and Matt Cartwright of Pennsylvania, introduced a bill called the Protecting Consumers from Unreasonable Credit Rates Act which seeks protections similar to those of the MLA. Currently, according to Congress’s website, the bill is in the process of being referred to the Committee on Banking, Housing and Urban Affairs, though according to GovTrack, a government transparency site, it has a 7 percent chance of getting past the committee, and just a 2 percent chance of being enacted.