As the federal government clamps down on traditional payday loans that cripple low- and moderate-income borrowers with unaffordable payments, lenders are shifting their businesses to installment loans that can be just as harsh on struggling people, the Pew Charitable Trusts warned Thursday.
Pew, a nonprofit public policy research group, is calling on the Consumer Financial Protection Bureau and state governments to prohibit some of the harshest interest rates and fees at a time when the federal agency is considering new rules for short-term loans people take out when desperate for money between paychecks.
Rather than face the federal rules that have been proposed by the consumer bureau, traditional payday lenders and auto title loan lenders are changing their focus to loans that will be paid off over many months. These installment loans differ from traditional payday loans that must be paid off in one lump sum relatively quickly. As the name payday suggests, the idea is that you get a short-term loan and then pay it off when your paycheck arrives.
Consumer advocates have complained that the lump-sum payments are often so huge for borrowers to handle, that they continually take on new loans to pay off earlier ones and dig themselves into a cycle of debt.
But simply converting to installment loans doesn't mean individuals will be able to afford them, said Nick Bourke, consumer finance project director for Pew. "They can still have dangerous interest rates and fees."
For example, he said in many states the fees and interest rates can amount to about a 400 percent annual percentage rate.
Pew emphasizes that while people have longer to pay off installment loans than the old short-term payday loans, the costs to borrowers remain huge. For example, a payday lender might provide a $500 loan for five months and charge the borrower $595 in fees and interest. Over the five months, the person would pay $219 a month for a total of $1,095.
Payday installment loans and auto title loans need to be regulated because of their unique structure in collecting payments, Bourke said. To get approved for the payday loans, people must give the lender the right to withdraw money directly from a person's checking account. And auto title loans give the lender the right to take away a car if a loan isn't paid.
Pew wants the consumer bureau and state governments to force lenders to eliminate fees, reduce interest costs and make sure people can afford the loans by limiting monthly payments to 5 percent of a person's pay. In addition, Pew wants the bureau to put a limit on refinancing payday loans.
Current lending practices are predatory, Bourke said, with lenders encouraging people with installment loans to refinance into new loans. It's a way that the lenders can collect new fees for originating a new loan and a way that individuals end up with expenses building on expenses.
Pew is one of many groups submitting recommendations to the consumer bureau during a period open until Oct. 7.
The Chicago-based Woodstock Institute also will be submitting comments, although it hasn't done so yet. Woodstock President Dory Rand says she disagrees with the 5 percent income limitation Pew wants to impose on borrowers. Holding a single loan to 5 percent of a person's income fails to show whether the borrower can truly afford the loan, Rand said.
The person may have multiple debts, and 5 percent might be way too high, she said. A single loan might look manageable, but "you might already be up to your ears in other loans."
She would like to see a requirement that the person can truly afford the loan based on their particular circumstances. She also questions the value of such oppressive loans: "They aren't allowed in 14 states and people get along fine," she said. "They borrow from friends or family. It's just not true people need these."
The auto title loans "are particularly egregious," Rand said. "People rely on their vehicle to get to work, take the kids to day care or go to the doctor."
As states and the federal government have considered regulation of payday loans, the industry has argued that if requirements are too stringent, low-income people won't get loans they need to get from paycheck to paycheck and will have overdrafts on bank accounts, turn to pawnshops or end up in bankruptcy.
Pew has pointed to Colorado as a state that has held APRs down to 115 percent without deterring lenders from giving the short-term loans.