The newest report from the Consumer Financial Protection Bureau targets payday loans — in prepared remarks released ahead of a speech today in Nashville, Tenn., CFPB Director Richard Cordray referred to them as “debt traps.”
Released today, the report found that four out of five payday loans (sometimes called cash advances or check loans) are renewed or rolled over, essentially negating the purpose of the loan product as a short-term financial solution for cash-strapped consumers.
A Troubled Problem Solver
Payday loans are small-dollar loans — typically $500 or less — that are designed as emergency financing to be repaid with the borrower’s next paycheck. In addition to the triple-digit APRs that are often charged, these loans carry steep origination fees, and consumers can end up paying much more than they borrowed in the first place. The CFPB report found that three of five payday loans are made to borrowers whose fee expenses exceeded the initial loan amount.
If you’re wondering how that adds up, it’s because these loans become much more cyclical than they were intended to be. Only 15% of borrowers repay their payday debts when due without re-borrowing within 14 days (the CFPB considers payday loans taken out within 14 days of paying off the previous loans to be renewals, or part of a loan sequence). Conversely, four of five borrowers end up defaulting on or renewing a payday loan within a year.
“We are concerned that too many borrowers slide into the debt traps that payday loans can become,” Cordray said, in a news release about the report. “As we work to bring needed reforms to the payday market, we want to ensure consumers have access to small-dollar loans that help them get ahead, not push them farther behind.”
About half of initial loans are repaid within one loan renewal, but about one in five initial loans leads to a sequence of seven or more loans. Overall, more than 60% of payday loans are made over the course of loan sequences amounting to seven or more loans. About half of all payday loans are made to borrowers in a sequence of 10 or more loans in a row.
“From this finding, one could readily conclude that the business model of the payday industry depends on people becoming stuck in these loans for the long term, since almost half their business comes from people who are basically paying high-cost rent on the amount of their original loan,” Cordray said.
Obviously, this isn’t a rosy picture of the payday loan industry. Still, it’s a commonly used product: About 12 million Americans currently have payday loans. With a consumer base like that, it’s clear that there’s a need for short-term loans, which the CFPB acknowledges, but it is also clear that these loans could use a redesign.
Cordray says payday loan changes could be on their way soon, saying the CFPB is in the late stages of considering ways to reform the industry. Meanwhile, millions of consumers bounce from one payday loan to the next.
More on Managing Debt:
- The Credit.com Debt Management Learning Center
- How to Pay Off Credit Card Debt
- 5 Tips for Consolidating Credit Card Debt
- Understanding Your Debt Collection Rights
- The Best Way to Loan Money to Friends & Family
- Top 10 Debt Collection Rights