Avoiding the Debt Cycle: Problems with Payday Loans

A recent report by the Consumer Financial Protection Bureau (CFPB) confirms what many consumers have experienced and many advocates have long claimed: payday loans are inherent debt traps, locking borrowers in a cycle of rollover loans that can last several months and ultimately cost hundreds of dollars in interest. With 80 percent of consumers rolling over payday loans five to six times, interest rates for these loans climb into the triple digits. Regulations are needed to protect consumers from harmfully designed and largely unchecked products in the financial marketplace.

The future of these products will affect many low-income Latino and other minority consumers. Significant racial and ethnic disparities exist in access to mainstream financial services. Research from the FDIC shows that 53 percent of Blacks and 43 percent of Hispanics are either unbanked or underbanked. This leaves little choice for these communities when seeking products and services to meet their financial needs.

Unfortunately, the most ubiquitous and convenient providers of these alternative financial products are payday loan lenders, nationally numbering more storefronts than McDonald’s and Starbucks combined. A new study released by the Center for Responsible Lending found that race and ethnicity are the leading factors in determining payday lender locations, with concentrations of these businesses in lower-income and largely minority communities.

According to testimony before the Senate Banking Committee, over 58 percent of payday loan borrowers report using them to pay monthly expenses such as utilities, rent, and food. However, a payday loan used to cover these basic expenses will usually require a balloon payment averaging $400 from a borrower’s very next paycheck. This results in a pattern for countless borrowers who pay off their loan and then immediately take out another loan to cover their cost of living expenses. This revolving door of loans creates a debt trap that can leave borrowers in a worse financial position than before they took out the original loan.

The CFPB recognizes the importance of addressing this issue. A recent CFPB field hearing in Nashville, Tenn., focused on payday loans. According to CFPB’s Director, Richard Cordray, given the need for more consistency and oversight in payday lending, the agency intends to issue a rule in the near future.

NCLR welcomes any effort to reduce household debt and help Latino families continue recovering from the economic crisis, and we will watch closely for CFPB action on this issue. While access to small-dollar credit is critically important for low-income families, the current structure of payday loans leaves little choice but to roll over loans once a borrower is ensnared in a debt cycle. When the interest and repayment terms prevent a reasonable likelihood of paying off the total balance, consumer protections vanish.

Consumers now have a federal agency to monitor nonbank products such as payday lending, which went unregulated for too many years. The CFPB has a responsibility to ensure that any forthcoming rules adequately protect consumers, especially those who are most financially vulnerable.