A classic mantra in credit is to not lend money to someone who needs it. When people get desperate and need to cover an electric bill or rental payment, the chances are that they will hit another bump in the road that will forestall repayment.
Enter the Pay Day lending business. Sky high rates for hard-money borrowers. Rates often come in triple digits; in Florida, $500 for two weeks will annualize to an APR of nearly 300%
The Consumer Financial Protection Bureau (the “CFPB” or “Bureau”) recently issued the long-awaited final rule concerning Payday, Vehicle Title, and Certain High-Cost Installment Loans (the “Final Rule”).
While it is clear that the Final Rule will ban certain practices that are currently central to the business model of payday lenders, vehicle title lenders, and other high-cost installment lenders, research evidences that the market demand allowing these products to flourish will persist.
The CFPB’s final rule does not settle the matter of where people will go to get the small amount of money needed to keep debt-strapped consumer lights on. The rule, which now requires a means test, will, in fact, keep people out of payday lending, but we are not sure where they will go to get urgent funds.
As stated above, the remainder of the Final Rule, which addresses collections and recordkeeping requirements, extends beyond those loan products subject to the underwriting and reporting requirements to include “Covered Longer-Term Loans,” which are defined as loans with greater than 36%.
Traditional credit cards will not help because the target market will not likely qualify for card programs that require decent FICO scores and the ability to repay. If people are going to payday lenders, they probably do not have the funds needed for a secured card, either.
There is undoubtedly a need for the service for the bottom 10% of household incomes. They do need budgeting flexibility to cover emergencies. A ruling like this will crush this market, at least by reducing loan throughput by 75%. It seems unpractical to just kill the lending channel in the spirit of social justice and not offer an alternative. What I would like to see is some state or federal fund, which allows for the loans and recaptures payment through tax refunds. At least, that will keep the lights on in many households!
Overview by Brian Riley, Director, Credit Advisory Service at Mercator Advisory Group
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