New Payday Loan Protections Revoked by the Consumer Financial Protection Board

Payday lending has long been controversial. While payday loan providers bill themselves as an important safety net for people in need of quick cash to cover unexpected expenses, these high-interest loans can be a trap for consumers–typically, the consumers who can least afford it.

According to data kept at the Alabama Department of Banking, in 2019, Alabamians borrowed about $563.6 million from lenders in Alabama and took out 1.6 million payday loans.  These loans generated $98.4 million in fees to the payday loan lenders.  A bill sponsored by Sen. Arthur Orr, R-Decatur to allow borrowers up to 30 days to repay a payday loan instead of shorter periods of as little as 10 days was killed by the Alabama Senate Banking and Insurance Committee by an 8-6 vote in February 2020.  

This committee couldn’t have known that in less than two months after its vote, most Alabama families would be facing a major financial crisis due to the impacts of COVID-19.   Ironically, payday lenders were classified as “essential businesses” during the pandemic shutdown.  A recent article from the Montgomery Advertiser showed that nearly three in four Alabamians wanted payday loan reform to extend terms and limit the interest rates of payday loans.   

How Payday Loans Work

Most payday loans are offered for a period of somewhere between 10 and 30 days. Unlike traditional loans, the borrower doesn’t make payments over time. Instead, the full amount borrowed plus the fee is due at a fixed point in the near future, usually on the borrower’s next payday.

When that date rolls around, many borrowers can’t spare the cash from that paycheck to pay the entire payday loan in full. The payday lenders will then allow the borrower to just pay the fee due and “renew or roll” the due date to the next payday.  Alabama law does offers some protections to the number of times a loan can be rolled over, the maximum number of payday loans a borrower can have at one time and a cooling off period so that the borrower is not just continually extending the same loan for weeks, months to a year at a time.  However, the workaround to those rules are well known in that most borrowers use multiple payday lenders to help them while they are trying to escape the payday loan “trap” of not being able to pay back the payday loan in full.  

Payday Loan Laws in Alabama

While some states have enacted stricter laws to limit or eliminate high-cost payday loans, Alabama law creates a specific carve-out that allows payday lenders to charge annual percentage rates as high as 456%, this rate would be illegal in other states. According to a 2019 report from Alabama Arise and the Alabama Appleseed Center for Law and Justice, Alabama has the third-highest concentration of payday lenders in the United States. 

More than 10% of the Alabama workforce had taken out at least one payday loan in a 12-month period, for a total of about 5,000 loans per day statewide. That’s more than 214,000 borrowers taking out nearly 1.8 million loans. Those loans generate more than $100 million in profits for the payday loan industry each year. 

Just How Much Does a Payday Loan Cost? 

The data provided in the report referenced above shows that an Alabama payday loan borrower who takes out a $500 loan and takes one year to pay back the balance will pay $2,275 in fees across that year.  For a full-time, minimum-wage worker, that means the cost of borrowing $500 is nearly eight weeks’ pay.

Even loans repaid more quickly can take a serious bite out of the budget, particularly for the lower-income borrowers most commonly targeted by payday loan providers. For instance, an Alabama payday lender can charge up to $17.50 per $100 loaned, and the loan term may be as short as 10 days. A consumer who takes out a 10-day, $400 loan on July 10 will owe $470 on July 20. If the borrower is able to repay the loan in full on July 20 and it doesn’t create a shortfall that triggers another round of borrowing a week or two later, that loan has cost $7/day. And, that rate continues. A 10-day renewal means another $70 fee, and so on. 

If the loan is paid off in 30 days, the cost is $210. If it takes 90 days to pay off, the cost of this particular loan is $630. The more money a borrower invests in paying those fees from loan term to loan term, the more difficult it is to catch up and stabilize his or her finances. And, that’s exactly what the payday loan model banks on. Borrowers must be diligent in getting a payday loan paid off fast to avoid spending money on fees that could really be used to help with the current financial needs of their families. 

Consumer Financial Protection Board Revokes Proposed Underwriting Guidelines 

When you apply for a traditional loan, the process involves underwriting. That means a financial professional looking at your income, debts, assets and other factors to determine how risky it would be to loan you money. The greater the perceived risk, the less likely it is that the loan will be approved. Though this sometimes creates an obstacle for lower-income borrowers or those with poor credit histories.  The lender minimizes risk, and the borrower doesn’t get trapped by debt he or she can’t afford. 

The CFPB’s proposed rule would have required payday lenders to do the same–in short, to take a look at whether or not you have the ability to repay before issuing a loan.  This change would have made it tougher for lower-income people to get payday loans without proving they could pay for the loan in underwriting. The rule would have cut down on the number of people who take out payday loans and ultimately end up trapped in the cycle of costly reborrowing.  Now, the multi-year effort to inject that layer of protection into the process has failed.

On the other hand, if the CFPB underwriting guidelines were in place, especially during the COVID-19 pandemic, where would lower-income families get access to money to feed their families or fix their only means of transportation if payday loans were not available?  Normally, these individuals are not able to meet the underwriting guidelines of traditional lending due to limited income and debt to income ratio guidelines.  Where would these families have to turn if they didn’t have access to payday lenders… illegal loan sharks or unregulated online payday lenders?  Probably so.  Lower-income families should be allowed access to lending, including payday loans BUT the Alabama legislature should be providing more protections for Alabamians using payday lenders by limiting the annual interest rate a payday lender can charge and extending loan terms allowing borrowers more time to pay off the payday loans.     

It is very important that consumers understand the risks of payday loans and think very carefully before taking them on. It’s also important that borrowers who are already caught in that trap recognize that they have options. For instance, most payday loans are dischargeable in bankruptcy. 

If you’re caught in a payday loan cycle you can’t afford and see no way out, talk with one of our experienced debt relief attorneys. Know your rights and options before you decide on your next steps. It’s free and there’s no obligation–just call 877-581-3396 or fill out the contact form on this page to get started.