As the payday loan market evolves, states must respond


State lawmakers need to be vigilant: Big changes are afoot in the payday loan market, many of which will be detrimental to socially responsible borrowers and lenders. Payday loans and long-term, high-cost auto title installment loans have grown significantly as companies diversify their business models in an effort to reduce their reliance on conventional payday loans. However, without state-level guarantees, these longer-term products often have excessive prices, unaffordable payments, and unreasonably short or long terms, and therefore can be as detrimental to borrowers as conventional payday loans.

What should states do?

State legislators who want a well-functioning small loan market will need to establish strong but flexible safeguards to protect consumers and ensure transparency. Lawmakers in states where payday loan stores operate should consider measures similar to Ohio’s Fairness in Lending Act (HB 123), which passed in July. The law tackles key market problems by lowering prices, requiring payments to be affordable, and giving borrowers a reasonable time to repay. It also includes crucial provisions to balance the interests of consumers and lenders, thereby ensuring widespread access to credit.

Table 1

Sensible Secures Big Leap Forward for Ohio’s Small Loan Market

How the State’s Equity in Lending Act Tackles Harmful Payday Lending Practices
Problem Ohio Law
Loan terms are too short, leading to unaffordable repayments and frequent reborrowing. Borrowers will have at least 3 months to repay a loan, or monthly payments on short-term loans will be limited to 6% of the borrower’s gross monthly income.
The loan periods are too long, which lengthens the indebtedness and increases the cost of borrowing. The total cost of the loan will be limited to 60% of the loan principal, eliminating the incentive for lenders to set unreasonably long repayment terms.
Prices are much higher than necessary to ensure widely available credit. Allows lenders to charge 28% interest plus reasonable monthly maintenance fees. That’s significantly lower than typical payday loan pricing, but sustainable for efficient lenders, meaning credit will keep flowing.
The anticipated charges make refinancing costly and prolong the indebtedness. Requires equal payments consisting of principal, interest and combined fees, with strong upfront fee protections.

Source: Pew Charitable Trusts

Ohio law is not perfect. Ideally, all covered loans should have had payments no greater than 5% of the borrower’s gross income (or 6% of net income), cap total costs at 50% of loan principal instead of 60% , and prohibit the pre-charged fee. (Although minimal, the $10 fee allowed for cashing the loan check is a hidden charge that has little or no justification, as the lender takes no risk in accepting a check of which it is the author.) But as The Pew Charitable Trusts explains in Written Comments to Legislators, the Fairness in Lending Act is a major step forward in protecting Ohio consumers who take out small loans, and it’s a model for other states that have payday loan stores. The following is a summary of the main issues that the law addresses.

Loan terms are too short

Research has shown that conventional payday loans are untenable because they fall due in full too quickly – usually around two weeks – and the required payment consumes a third of a typical borrower’s paycheck. Additionally, payday lenders are the first creditors to be paid because they can access the borrower’s checking account on payday. While this strong ability to collect payments facilitates the flow of credit to borrowers with damaged credit histories, it also means that lenders generally fail to ensure that borrowers can repay the loan and successfully meet their other obligations. financial. To more closely align the interests of borrowers and lenders, state policymakers should ensure these loans are safe and affordable by limiting monthly payments to 5% of the borrower’s gross salary. In Ohio, as part of the compromise, lawmakers gave borrowers at least three months to repay and limited monthly payments on short-term loans to 6% of gross monthly income.

Loan terms are too long

Small installment loans with unreasonably long terms can lead to extremely high costs because only a small proportion of each payment reduces the principal; the rest goes towards interest and fees. For example, a $300 loan with an 18-month term can result in a total repayment of nearly $1,800, or about six times the amount borrowed. To ensure that the repayment period is not excessive, legislators should limit the total cost of borrowing to half the amount borrowed. So the maximum charge on a $300 loan would be $150. This would ensure that lenders do not reap additional fees by setting unnecessarily long terms. Ohio lawmakers have limited the total cost of loans to 60% of the amount borrowed.

Uncompetitive prices

Payday lenders charge more than necessary to make credit available, but states can cut costs while allowing businesses to make a profit. For example, Colorado’s 2010 reform resulted in the cheapest payday loan market in the country while maintaining widespread access to credit. In 2016, an average payday loan of $392 in the state lasted three months and cost $119 (129% annual percentage rate, or APR); Nevertheless, payday lenders that operate profitably in Colorado charge borrowers from other states much higher prices. In Ohio, payday lenders will be allowed to charge a little more than in Colorado for the shortest loans and a little less for those that span six months or more, with APRs automatically decreasing as the amount of loans increases. This structure sets up a well-balanced market and allows loans up to $1,000 without putting consumers at risk.

Initial costs

Providing a secure market for installment loans requires a predictable path out of debt. Legislators can achieve this by requiring that small dollar loans be repaid in substantially equal installments of combined interest, fees and charges and that in the event of prepayment or refinancing, all loan fees be repayable on a pro rata basis. , which means that borrowers would not pay for the remaining days. the loan after full repayment. By contrast, allowing prepayment penalties or early fees, such as non-refundable origination fees, provides a strong incentive for lenders to push borrowers to refinance in the first months of a loan and acts as a penalty for borrowers who repay the loan earlier.

Conclusion

State lawmakers can take steps to make small loans safer for consumers while allowing lenders to provide credit and earn profits. Ohio lawmakers did just that. If other states want to follow suit, they should enact measures that address current market issues – using the solutions outlined above – and include in their legislation other consumer protections that Ohio has addressed in its Fairness in Lending Act.

Nick Bourke is the director and Olga Karpekina and Gabriel Kravitz are senior partners of The Pew Charitable Trusts consumer credit project.

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