Unforeseen expenses from medical bills to auto repairs can add up fast, causing many people to fall behind on recurring bills such as mortgages, car loans, childcare, and much more. People that find themselves unable to keep up with their monthly payments sometimes turn to payday loans as a way to quickly supplement their income.
Payday loans are classified as “short-term, high interest loans that are generally due on the consumer’s next payday after the loan is taken out. The annual percentage rate of these loans is usually very high – i.e., 390% or more.”1 In many cases, because the interest on these types of loans is so high, people end up falling behind on payments and taking out additional loans to pay the accrued interest on the original loan. This cycle often drives people deeper and deeper into unmanageable debt. In general, payday lenders often “operate in low-income communities”2 where people are more likely to live paycheck-to-paycheck, making them more susceptible to the promise of fast cash.
Today, payday loans are a “contentious topic in the United States, particularly when it comes to regulation.”3 Supporters of such loans believe that these types of loans can help alleviate temporary financial burden when people have no other alternatives. On the other hand, opponents argue that the enormous interest on such loans are more likely to negatively impact borrowers in the long term.3
As it stands, the “Payday Lending Rule requires lenders to view borrowers’ pay stubs, check with employers, or otherwise confirm borrowers’ ability to pay back their loans.” These measures are set in place to ensure that borrowers are able to pay back the loan when it’s due. However, there are proponents of a rule change that argue a “looser rule will ensure that those borrowers have more credit options.”2
As of February 6th, “an overhaul of the payday loan regulations began, to be in effect August 2019. The most concerning change to the regulations is the “ability to pay” that ensured lenders “would have to verify a borrower’s income, debt and spending habits to assess their borrowing threshold before underwriting their loan — or avoid this stipulation by changing their loan type to an installment loan, paid over a set amount of time agreed upon at the outset of the loan. 2
Under the proposal (PDF), which amends the 2017 Payday Lending Rule, lenders would not have to confirm that their borrowers have the means to repay some types of loans. Eliminating the “ability to pay” requirement would affect loans with a term of 45 days or less. It also would target single-payment vehicle title loans, in which borrowers put up their cars or trucks for collateral, and longer-term, balloon-payment loans.”2
Although payday loans are one option that people rely on, financial institutions are well positioned to become the primary lenders by offering loan programs with lower rates and fees. The Pew Charitable Trusts “has called for mainstream banks to offer less risky small loans to help consumers when they hit financial potholes.” One such example is the U.S. Bank loans that target this demographic and “include some features that Pew recommends...such as limiting loan payments to 5% of the borrower’s monthly income and avoiding overdraft fees.”4
According to Pew’s research, 12 million people a year take payday loans. If borrowers can’t make the payment, they often pay more fees to renew the loan. Payday borrowers, Pew found, spend an average of $520 in fees to repeatedly borrow $375. U.S. Bank’s new loans cost $12 for each $100 borrowed, when payments are automatically debited from a customer’s account. The fee is $15 per $100 if a customer opts out of automatic payments.”4
Furthermore, “some credit unions offer “borrow and pay” programs, in which part of customers’ payments go into a savings account that they can draw on once the loan is repaid.” People can also benefit from payday loan alternatives also know as PALs that “allow members of some federal credit unions to borrow small amounts of money at a lower cost than traditional payday loans and repay the loan over a longer period.”5
Payday loans are generally a last resort for most consumers, but when it comes down to it people need better options in their time of need. One solution is for banks and credit unions to provide loan programs that meet the needs for people with low-income or bad credit that otherwise have trouble getting approved for a traditional type loan. A more long-term solution is for people to start creating positive financial habits such as creating an emergency fund, tracking their spending, and monitoring their finances more closely with digital money management tools.
At MX we believe that financial stability starts by giving people the tools and offers they need to manage their finances proactively. Using our data enhancement capabilities we were able to help one of our clients identify which of their customers were utilising payday lenders and create a campaign that offered one of their specific customer segments short-term money options as an alternative to external, high-interest loans.
When financial institutions use data to better understand their customers and offer digital money management tools, they can help them set financial goals to pay off debt faster, create budgets to track spending, and gain a full picture of their money movement, making it easier for them to make well-informed decision in the long term—effectively reducing the need to rely on predatory lending when they’re in a time of need.