Payday loans are unsecured short-term loans made at storefronts and online. The average loan amount is $375, ranging generally from $100 to $500, most often due in two weeks or on the borrower’s next payday. It is estimated that approximately 12,000,000 Americans have taken a payday loan in the last year. To be eligible for a loan, borrowers must have a steady source of income and a checking account. In many states, the law requires that the borrower not have other payday loans outstanding.
Payday loans are most frequently used by constrained consumers who have few or no liquid assets and limited opportunities to borrow on credit cards or from other mainstream lenders. The proceeds are generally applied to expenses that are either unexpected or cannot be postponed. Since many borrowers live from paycheck to paycheck and have very little discretionary income, even small interruptions in income, or unexpected expenses, may cause hardships and financial emergencies. Payday loans thus provide an opportunity for consumers to smooth income or consumption under circumstances where their rainy-day savings may be near zero and where other forms of credit are already fully utilized or unavailable. In such cases, payday loans, though expensive, may be economically preferable to alternatives such as defaulting on other obligations or foregoing needed goods and services.
Some large storefront lenders, and nearly all online lenders, employ the services of a subprime credit bureau, such as Clarity or Teletrack, to confirm the applicant’s eligibility. In some states, lenders are also required to query a statewide database to determine whether an applicant has other payday credit outstanding.
Payday lending is highly regulated at the state level—including through usury limits, maximum loan amounts, and proscribed collection practices—and is subject to existing federal laws covering consumer credit generally, such as the Truth in Lending Act, Equal Credit Opportunity Act, Electronic Funds Transfer Act, and the Gramm-Leach-Bliley Act. In multiple surveys, consumers overwhelmingly reported being satisfied with their payday borrowing experiences. Nevertheless, the Consumer Financial Protection Bureau (CFPB), a regulatory agency established by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, is set to issue a rule that could destroy most of the payday loan industry. On June 2, 2016, the CFPB published a comprehensive notice of proposed rulemaking covering payday loans and most other forms of high-cost consumer credit.
The CFPB’s own impact analysis suggests that the rule will result in an industry-wide revenue reduction of roughly three-fourths. Furthermore, industry studies show that around three fourths of the nation’s 20,000 storefront payday outlets will be rendered unprofitable and forced to close by the CFPB’s rulemaking. Assuming an average of about $15 billion of average payday credit outstanding, then, in the 75-percent-off proportion, roughly $11 billion of credit will be eliminated by the rule. The soon-to-be-excluded borrowers of that $11 billion will be forced to seek inferior substitutes, such as illegal loansharking or more expensive “mainstream” credit vehicles for which they will incur late charges and bank overdraft fees. The burden of this loss of credit access will be felt disproportionately by lower income and minority borrowers.