How low-cost loans and flexible compensation could challenge the inequity of payday loans

• Payday lenders are targeting black and Latin communities, creating more stores in minority neighborhoods.
• But for those who live paycheck to paycheck, predatory loans may seem like the only option.
• Fintechs offering small loans and early access to wages could replace those that need short-term liquidity.
• This article is part of a series called “The Cost of Inequity,” which examines the barriers faced by marginalized and disenfranchised groups in various sectors.

Payday loans are known to be a financial tool that attacks the less fortunate. But for many, they still serve as a lifeline between paychecks.

Malls across the United States are littered with payday lenders, advertising “EZ MONEY” and “CA $ H NOW”.

Although the total number of payday loan stores has declined over the past decade, it is still a significant market. About 12 million Americans take out payday loans each year, according to Pew Charitable Trusts.

But with increased regulatory oversight and competition from new technology-driven competitors, the days of payday lenders may be numbered.

Under a new administration, federal regulators such as the Consumer Financial Protection Bureau (CFPB) are increasingly focusing on payday lenders and may reinstate stricter underwriting rules repealed by the previous administration.

Payday loans create debt traps

Consumers typically borrow $ 375 from payday lenders, with fees of around $ 55 on average, according to the CFPB. A charge of $ 55 on a two-week $ 375 loan is about 15% interest, a great rate compared to credit cards.

But when annualized, those terms add up to an APR of 382%. More often than not, borrowers fail to repay payday loans within two weeks, resulting in a cycle of debt.

“We know that payday loans are generally short-term loans designed to create a long-term debt trap,” Charla Rios, a researcher at the Center for Responsible Lending (CRL), told Insider.

About 75% of payday lender income comes from fees generated by borrowers who take out loans more than 10 times a year, according to the LCR. In the 34 states that allow triple-digit interest rates – other states have adopted price caps – the fees cost consumers $ 4 billion each year.

Payday lenders are not required to assess the repayment capacity of consumers. They also frequently need access to consumers’ bank accounts to deposit the loan and then to debit it when it is repaid.

If the borrower does not have enough money in their checking account, it could lead to several overdraft fees. Payday lenders can also sell unpaid loans to debt collectors.

Payday lenders are concentrated in minority neighborhoods

Much of the criticism of payday lenders stems from the fact that they are often more present in neighborhoods with high concentrations of people of color.

“Research conducted by both the Center for Responsible Lending and many other consumer advocates across the United States consistently and consistently shows that payday lenders have typically located their stores in communities of color,” Rios said. . CRL has conducted research in states such as California, Colorado, Michigan, and Florida.

A similar trend was observed in Minnesota, according to a 2016 report: Neighborhoods that had payday loan stores within a 2.5 mile radius have twice as many black residents as the rest of the state.

And even controlling for income, CRL found that in Florida there were more payday loan shops in high-income, high-minority communities, Rios said.

Regulators have gone back and forth to reign in the breakdown industry

The regulators have analyzed payday lenders in recent years.

The CFPB issued a rule in 2017, whose major tenants required payday lenders to assess borrowers’ ability to repay the loan, notify them before attempting to debit their bank accounts, and limit the number of times a lender could attempt to draw on a borrower’s bank account.

The rule was supposed to come into effect in August 2019, but was eventually pushed back to November 2020. The CFPB also repealed the underwriting standards for payday lenders to assess the repayment capacity of consumers.

But under a new administration, recent statements from the CFPB indicate the agency’s renewed focus on payday loans.

“Years of CFPB research have revealed that the vast majority of this industry’s income came from consumers who could not afford to repay their loans, with most short-term loans being re-borrowing chains of 10 or more.” , wrote acting director Dave Uejio in a declaration in March.

Uejio noted that the previous administration had repealed underwriting rules that would resolve such harms for consumers and hinted at possible regulation in the future.

“The bureau believes that the damage identified by the 2017 rule still exists and will use the authority provided by Congress to address it, including through vigorous market surveillance, oversight, enforcement and, where appropriate, regulation.” , said Uejio.

Small loans and access to earned wages offer an alternative

While payday loans meet a need for many, especially the unbanked and those with little or no credit, there are alternatives.

One such low dollar lender is OppFi, which goes public through SPAC. It caters to consumers with no credit or low credit and offers loans of $ 500 to $ 4,000 at rates between 59% and 160% for terms of up to 18 months.

Granted, these are expensive terms. But OppFi first tries to steer its customers towards cheaper regular credit. For each loan request, OppFi offers to do a check on behalf of the consumer to see if they are eligible for a near premium loan from traditional lenders. 92% of the time candidates don’t get any offers, OppFi CEO Jared Kaplan told Insider.

And OppFi’s loans are meant to help its customers build credit, Kaplan said. Each payment is applied to the principal balance of the loan, there are no fees and OppFi does not sell its loans to debt collectors.

Access to Earned Pay, where consumers can access funds they’ve already earned between paychecks, has also emerged in recent years, often marketed as an alternative to payday loans.

Many paid access players, like DailyPay and PayActiv, are partnering with employers to reach consumers. There are often fees associated with the product, but because these players are integrated with payroll systems, they do not directly debit bank accounts that may be insufficiently funded.

DailyPay, for example, found in a survey that 70% of users say they no longer have to take out payday loans, and 78% say leveraging wages earned helps them avoid late fees. Payroll giant ADP is also developing products to access earned wages.

There are disadvantages. For both third-party apps and built-in payroll providers, there are privacy concerns. Employees may be reluctant to use these products if they think their employers may be able to keep up with this activity.

Other market players go directly to consumers, such as Dave and Earnin. They operate on tip models, where users decide how much to pay in addition to the salary they rely on, which can also be viewed negatively.

Tipping patterns have come under scrutiny by regulators. In 2019, the New York Department of Financial Services, along with several other states, launched an investigation into earned salary access companies, specifically focusing on tip models, their impact on consumers’ access to earned wages, funds and whether they constitute interest rates.

“One of the things to consider is that when you get people to tip, it can actually add up to a high APR,” Rios said.