The Trump administration on Wednesday rolled back protections set to make payday loans less risky for borrowers, which could affect millions of young people: Almost 10 million millennials have taken out one of these high-interest, short-term loans in the past two years.
The Consumer Financial Protection Bureau, the government agency tasked with regulating financial companies, said it plans to abandon Obama-era payday loan stipulations that would require lenders to ensure borrowers could repay their loans before issuing cash advances.
“This proposal is not a tweak to the existing rule; instead, it’s a complete dismantling of the consumer protections finalized in 2017,” says Alex Horowitz, senior research officer at Pew’s consumer finance project. Over the past eight years, Pew Charitable Trusts has extensively researched the payday loan market and weighed in on policy proposals at the state and federal level.
The Obama-era rules were already starting to work, Horowitz says: “Lenders were making changes even before it formally took effect, safer credit was already starting to flow, and harmful practices were beginning to fade.” So there was no real reason or need, he says, for the shift.
The problems with payday loans
Payday loans are loans of typically $500 that you can get in most states by walking into a store with a valid ID, proof of income and a bank account. In recent years, lenders have even made them available online. The repayment process is the same: the balance of the loan, along with the “finance charge” (service fees and interest), is typically due two weeks later, on your next payday.
These loans can be extremely risky because they’re expensive: The national average annual percentage rate (APR) for a payday loan is almost 400 percent. That’s over 20 times the average credit card interest rate.
And often, borrowers can’t pay back the loan right away. The Consumer Financial Protection Bureau found that nearly 1 in 4 payday loans are re-borrowed nine times or more, while Pew found it generally takes borrowers roughly five months to pay off the loans — and costs them an average of $520 in finance charges. That’s on top of the amount of the original loan.
“Payday lenders have a predatory business model where they profit while families are plunged into an unaffordable debt trap of loans at rates that reach 400 percent APR or higher,” says Lauren Saunders, associate director of the National Consumer Law Center.
Personal finance expert Suze Orman recently railed against these loans, saying even federal employees affected by the record-breaking partial government shutdown should avoid them.
“I am begging all of you, do not take a payday loan out,” she said on a special episode of her podcast “Women and Money” for federal employees affected by the shutdown. “Please don’t do it. If you do it, it will be the biggest mistake you have ever made.”
Federal agency now wants to rescind safeguards
To help ensure borrowers were not getting sucked in this so-called debt trap, the CFPB finalized a new, multipart payday loan regulation in 2017 that, among other things, required payday lenders to double-check that borrowers could afford to pay back their loan on time by verifying information like incomes, rent and even student loan payments.
The new set of rules were to apply to a wide range of short-term credit products beyond just payday loans, including auto title loans.
To give companies time to adjust, the CFPB originally scheduled the rules to go into effect in August 2019. The Trump administration directed the agency to delay implementation, however, and first conduct another review.
On Wednesday, the CFPB announced that it had finished its review and found the “ability to pay” requirements would restrict access to credit. Therefore, the new leadership at the agency proposed abandoning these safeguards.
In a statement issued Wednesday, the CFPB said its decision is based, in part, over concerns that the verification requirements “would reduce access to credit and competition in states that have determined that it is in their residents’ interests to be able to use such products, subject to state-law limitations.”
The agency said that there was “insufficient evidence and legal support” for the verification requirements, adding that “rescinding this requirement would increase consumer access to credit.”
The CFPB did keep in place restrictions that bar payday lenders from repeatedly trying to directly withdraw payments from a person’s bank account. Some payday lenders attempt to recover their money by taking what they’re owed directly from borrowers’ checking accounts, which borrowers grant access to as a condition of the loan. But unexpected withdrawals from the lender can rack up pricey overdraft fees and damage credit scores.
However, these restrictions won’t take effect until at least November 2020.
The scope of the payday problem
Despite the risk, payday lenders are a booming business in the U.S. Across the country, there are approximately 23,000 payday lenders, almost twice the number of McDonald’s restaurants.
And these loans transcend generations. Within the past two years, 13 percent of millennials (ages 22 to 37) report taking out payday loans, according to a survey of approximately 3,700 Americans that CNBC Make It performed in conjunction with Morning Consult. Pew estimates there are currently 75.4 million millennials in the U.S.
Perhaps even more alarming, Gen-Z (those age 18 to 21 years old) are also looking into these high-risk loans. Almost 40 percent have strongly contemplated taking one out, according to the Morning Consult survey, in some cases to cover costs associated with attending college.
University of Kansas senior Austin Wilson contemplated taking out a payday loan last summer when his $600 off-campus housing deposit was due before his student loan disbursement kicked in.
“I know payday loans are traps,” he told CNBC Make It. “But I figured if I could stay on top of it, I know I’m going to get this money, so I just need to pay my rent.”
In the end, Wilson was able to find a friend to lend him money and pick up extra shifts at work to cover the shortfall. But millions of young borrowers like him may not be as lucky — and now, they may face fewer protections when forced to rely on these high-cost loans.