Payday pitfalls

Since its creation in 2010, the Consumer Financial Protection Bureau has stuck its nose in every imaginable issue involving consumer finance, and even, as I recently noted on this page, in some issues that don’t. The consumer bureau has now released a payday lending proposal that looks like another example of regulators gone amok. But this time they may be on the right track.

With a payday loan, the lender gives the borrower a little cash (the average is $350) in return for the borrower’s promise to pay back the loan a short time later. Sometimes repayment comes from the borrower’s next paycheck, as the name suggests, but the term has come to mean almost any very short-term consumer loan. If you live in one of the 36 states where, according to The Pew Charitable Trusts, payday lenders still operate, you’ve probably seen their signs, often near dollar stores.

Under the consumer bureau’s proposed rule, a lender that does not “reasonably determine” that the borrower is able to repay before making the loan can be sued for having committed an “abusive and unfair” practice. The rule applies to all consumer loans meant to be repaid in 45 days or less, and to loans over 45 days if the interest rate is greater than 36 percent and the loan will be paid from the borrower’s paycheck or is secured by the borrower’s car. Since these have always been “no questions asked” loans, the new rule could upend the payday lending industry. It will force these lenders to act like banks, which will sharply increase their costs and could drive most out of business.

This may be a good thing. The effective interest rate on payday loans is staggering—the interest rate for a $50 loan that requires the debtor to pay $70 in a month is 40 percent, which translates to 480 percent per year. And far too many borrowers “roll over” the loans: When the first loan comes due, they borrow the money they need to repay it. Each month the loan gets a little bigger, and pretty soon the borrower may be in way over his or her head.

The National Association of Evangelicals has applauded the consumer bureau’s proposal. After outlining seven biblical principles for lending and borrowing (“Don’t take advantage of the vulnerable,” “Don’t charge excessive interest,” “Lend generously”), NAE vice president of government relations Galen Carey described his organization as “grateful” for the rule at a recent consumer bureau hearing. The NAE has a point here. The Bible shows great concern for vulnerable borrowers, as when God says a lender must return any cloak taken in pledge at sunset so that the borrower can keep warm at night (Exodus 22:25-27).

Why not just ban payday lending altogether? If it could, the consumer bureau probably would. But the bureau is not permitted to regulate interest rates, and courts might strike down a rule that seemed to be doing the same thing—banning high-interest loans.

Payday loans also aren’t all bad. For some borrowers, they really are a quick source of much-needed cash in an emergency. We need to consider what borrowers would do if payday loans disappeared. Some might turn to even less reputable lenders such as loan sharks.

The consumer bureau’s rule could sweep away good payday loans along with the bad ones. I might prefer a rule limiting the number of times a loan can be renewed and extended. That would weed out most of the abusive loans, without forcing payday lenders to abandon their traditional lending model.

In this case, though, even a heavy-handed rule is better than leaving borrowers exposed to the pitfalls of payday loans.