Looking for fast food? There is probably a McDonald’s nearby where you can get your fix. Looking for fast cash? In the majority of states, there is even more likely to be a payday lender near you than a McDonald’s. Both types of establishments promise to serve you quickly and easily, but don’t be fooled: a payday loan is no better for your wallet than French fries are for your waistline.
Here is how a payday loan is dished out: the lender gives the borrower a small loan—typically a few hundred dollars—in exchange for her agreement to pay back the amount borrowed, plus a sizeable fee, in a week or two. The borrower must give the lender a post-dated check or electronic account access for the total amount of the loan plus the fee. When the loan’s due date arrives, the lender can cash the check or debit her account. The cost of this type of loan is super-size: it usually carries an Annual Percentage Rate (APR) in the triple or even quadruple digits. The borrower generally can’t afford to pay it back in full on its due date, so she must roll it over or take out new loans to try to stay afloat. This cycle creates a debt trap that ensnares the borrower, harming her as well as her family and community.
Payday loans aren’t the only dangerous, high cost small dollar loan product on the menu in many states. The borrower can also get an auto title loan, in which she gives the lender the title to her car as security for the loan. If she can’t pay back the amount borrowed, plus the expensive fee, by the due date, the lender can keep and sell off her car. The icing on the cake: in some states, if the borrower owes more on the loan than the car sold for, the lender can still come after her for the deficiency.
Fortunately, many states are doing just what the doctor ordered and taking these and other predatory small dollar loan products off the market. A recent article in the Suffolk University Law Review, Small Dollar Loans, Big Problems: How States Protect Consumers from Abuses and How the Federal Government Can Help , looks at how well each state is doing in keeping lenders from serving up rotten loans to borrowers. If states impose a 36% APR cap or an outright prohibition on payday and auto title loans, they are awarded a “Pass.” If not, they fail. States are also graded on how high an APR they allow lenders to charge for two common types of small dollar installment loan products (structured so that a borrower has to make payments at regular intervals, typically every month). Again, a 36% APR cap gets a “Pass,” while anything over that is a “Fail.” The 36% APR cap is a benchmark that states have used as a fair rate for small dollar lending since the first half of the twentieth century. (For more on the significance of the 36% APR cap, as well as a list of some good alternatives to payday loans, please visit Stopping the Debt Trap: Alternatives That Work, Ones That Don’t.)
As of the writing of Small Dollar Loans, Big Problems, Arkansas, Connecticut, the District of Columbia, Maryland, New Jersey, New York, Pennsylvania, and Vermont, earned Ps in all four categories—a perfect score! (After the article was written, Montana was due to join this elite group.) Unfortunately, a greater number of states failed miserably. Delaware, Idaho, Illinois, Minnesota, Mississippi, Missouri, Nevada, New Mexico, South Carolina, South Dakota, Tennessee, Texas, and Utah earned straight Fs.
So how do we ensure the financial health of borrowers across the country? Here’s the recipe for success, spelled out in more detail in Small Dollar Loans, Big Problems:
States that don’t have a 36% APR cap on all types of small dollar loans should enact one to keep their residents safe.
Congress should establish an across the board 36% APR cap for all small dollar loans to protect all borrowers nationwide.
The newly-created Consumer Financial Protection Bureau (CFPB) should get in on the action and make sure that any applicable APR caps under state or federal are followed—and that lenders can’t sneak around APR requirements by charging junk fees and using technicalities to exclude these fees from the APR calculation.
If small dollar loans over 36% APR are going to be permitted, they need to be made safer. States and the CFPB should:
o Prohibit lenders from using dangerous forms of security, such as check or title-holding or electronic access to borrowers’ bank accounts.
o Require that loans have a minimum term of ninety days or one month per $100 borrowed and be repayable in installments rather than lump sum balloon payments (the way payday and title loans currently are).
o Require lenders to determine that borrowers can actually afford to repay the loans before the loans are made.
Leah Plunkett joined NCLC as a staff attorney in September 2009. Her work focuses on predatory lending (at the state level), auto policy, protection of exempt funds, and the consumer needs of domestic violence survivors.