Nearly eight in 10 workers say they live paycheck to paycheck, according to a 2017 survey of 3,462 full-time employee from Career Builder. If that sounds like you, and you don’t have an emergency fund or a generous relative to fall back on, then surprise expenses can put you in a tight spot.
But arms break, pipes burst, kids get sick — and to cover those surprise expenses that come due before payday hits, some 12 million Americans each year take out something called a “payday loan” from lenders with names like Cash America and Easy Money. According to estimates from Pew, the often low-income borrowers have accrued some $9 billion in fees, at an average of more than $500 per borrower.
These products have long been denounced as exploitative and predatory, and can charge annual percentage rates of more than 600%. On Thursday, the Consumer Financial Protection Bureau announced a series of new rules to rein in the payday loan industry and prevent what it calls “debt traps,” where borrowers are stuck in never-ending cycles of debt, taking out new loans to pay the old ones off.
Under the new rules, which will not go into effect until at least 2019 — barring any roadblocks from the Trump administration — payday lenders will have to verify your income and expenses before issuing the loan. More specifically, they will now be required to determine that the borrower can still cover their living expenses for the full term of the loan and 30 days after the highest payment on the loan. “Stated” incomes and expenses can be used if documentation is unavailable. Borrowers will also no longer be able to take out more than three short-term loans in a row.
“Too often, borrowers who need quick cash end up trapped in loans they can’t afford,” CFPB director Richard Cordray said in a press release about the rules. “The CFPB’s new rule puts a stop to the payday debt traps that have plagued communities across the country.”
‘Debt traps’ are startlingly common
More than 80% of payday loans are re-borrowed within a month, the CFPB has found. What’s more, most borrowers take out at least 10 loans in a row. “They end up in the cycle of poverty, in the debt cycle, and they never get out of it,” Jiaying Zhao, an assistant professor of psychology at the University of British Columbia who has studied the scarcity mindset that leads people to take out these kinds of loans, said in a phone interview.
Take Gloria James, a Delaware housekeeper profiled in a 2017 Economist article, who paid $1,620 in interest on a $200 loan. James, who makes $12 an hour as housekeeper, eventually succeeded in getting a judge to dismiss the debt, but her situation is common.
On the flip side, the seemingly crazy rates may be necessary for these kinds of short-term loans to be viable as a business model. At least that was the finding of a 2005 paper from the Federal Deposit Insurance Corporation, as well as a 2015 study by the Center for Responsible Lending. Default rates by borrowers can be as high as 53%.
When will the new rules take effect?
The new rules will go into effect 21 months after they appear in the Federal Register, according to the CFPB’s announcement. There is also a chance that the administration could move to block them. A June 12 Department of Treasury report of proposed changes to the Dodd–Frank Wall Street Reform and Consumer Protection Act — which created the CFPB in the first place — suggested that the agency’s independent structure had “led to regulatory abuses and excesses.”
That report led many to believe that defanging the CFPB will be a priority of the Trump administration. “The chances of this going into effect are pretty low,” NerdWallet credit expert Liz Weston said. “The fact that the head of the CFPB is still there does not mean that everything is hunky dory with the administration. ... it’s realistic to expect that at some point, there’ll be someone else in charge and they are not going to be as willing to take on the payday loan industry.”
Need a payday loan? Here are better alternatives.
Regardless of whether the new rules go into effect, there are better existing options for consumers. Reaching out to friends, family, faith organizations or even your employer for a loan or advance should be step one in a true emergency.
Next look to other sources available to consumers. “If you have good credit and a paycheck, and obviously everyone who does a payday loan has a paycheck, there’s no reason why you should darken the door of a payday lender,” added Weston. “You can get a personal loan through a credit union or online, and if you have a credit card you can get a cash advance.”
The most obvious alternative is to use your credit card. “The typical credit card comes with a 16% APR and several potential fees, and the terms are worse if you have poor or thin credit, but they are nothing compared to what can come with a payday loan,” CreditCards.com’s senior industry analyst Matt Schulz said in an email.
If you don’t have a credit card, or can’t get one on short notice, you may be able to secure a small personal loan from a local lender or credit union. If you’re having trouble making payments on any kind of loan, it’s never a bad idea to call your creditors and discuss your payment options and whether they can extend you a grace period.
Finally, NerdWallet also has a helpful list of more than 200 payday loan alternatives, many of them nonprofits, who might be able to provide a cheaper short-term loan or other forms of financial assistance.
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