It’s Time For Changes to Payday Loans

March 06, 2015

In what is a positive development for many Americans, not to mention society at large, there are some changes coming to the world of payday loans. The CFPB (Consumer Financial Protection Bureau) is rolling out some new regulations for the short-term loan industry that can only be viewed as a good thing by the borrowers. (Maybe not so much for the owners of the lending companies, though.) 

This industry has grown rapidly since the ’08 recession started.  It’s now a $46 billion industry!  Who knew???

I was in the car recently and heard 3 or 4 ads for short term loans. The industry has moved from strip malls/shopping centers to radio and online ads. It has been slowly growing and sadly, the people who use these loans are typically at a vulnerable point in their life and can least afford to be taken advantage of.

These loans are usually for a week or two, sometimes for a month or two. The interest rates are exceptionally high, in the 20’s and even 30+ percent. If there are upfront fees, and they get included into the total cost, the true interest rates can be upwards of 40-50%. People run out of money in their budget but still have to pay the electric bill, put food on the table and pay for transportation to/from work. The borrowers often have no other way that they can imagine to pay their bills and keep life running.

I have a friend who I thought was as likely to have a payday loan as he was to take a vow of celibacy and during a hike recently, he asked me about them and what he could do to unwind the loan cycle that he had fallen into. He got into his first payday loan when he was going through his divorce and needed to pay for an attorney. He had moved from his house into a nice apartment not too far away and his soon-to-be-ex-wife was still a stay-at-home mom so he was paying for the expenses at both residences.

Oh, he also had two kids in private schools at the time. There were a lot of outflows in his budget and the inflows weren’t keeping up. He started with a $500 loan for two weeks so that he had money for his security deposit at the apartment complex. He couldn’t pay it off when it was due, so a higher balance rolled to a new loan along with some fees.  He kept expecting to be able to pay it back but things kept coming up that needed funding and he kept rolling this loan along and periodically increasing it.

By the time we went on the hike, he owed roughly $7,500 that he really didn’t have…or at least he didn’t think he had it. He was stressed and quite frankly a bit embarrassed to tell me, his old college teammate, about the situation. He viewed it as a personal failure.

The good news about teammates is that they are there in good times and bad. We talked about his resources and how he could get this in the rear view mirror. With each passing loan cycle, he was feeling more and more trapped and not sure how to escape.

After our conversation, he is going to take a few steps to see if progress can be made. He is going to call his landlord and ask if there is a way to have a one-month payment holiday so that he can help recover financially. He is going to shop for a far less expensive cell phone plan and cable TV plan. He might just cancel cable altogether (a growing trend) and use Hulu and Netflix instead.

He is also going to consider using a 401k loan to pay off the payday loan. While I’m not a huge fan of borrowing against your 401k, I can’t look at his situation and not think that it would be a far better option than constantly rolling these payday loans forward. He will focus on getting his budget back in order and maybe move from the nice apartment he calls home now to a smaller place with fewer amenities, but a far lower monthly rent. He has a number of partial solutions to keep him from experiencing setbacks like this again, and if he cobbles together a few partial solutions, he will find that he has an actual solution.

I am happy that the CFPB is making it tougher for payday lenders to expand their business model, which far too often preys on those with the least knowledge and the least ability to repay. The industry has a place, but it is limited.  If you find yourself in a situation where you are considering it, here’s a line from HBO’s John Oliver “ If you’re thinking about getting a payday loan, pick up the phone, then put it down and do literally anything else.”   While that might be an overstatement, it echoes the sentiments of most people in the financial planning business.

 

 

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