The federal watchdog agency for consumer financial products just released a draft of national rules for the payday lending industry. In most states, these rules are a welcome first step toward reining in payday lenders, whose business model involves charging an average of 300% annual interest, mainly to low-income people who can least afford those predatory rates. In New York, however, we need to defend our already-strong consumer protections.
Like 13 other states and the District of Columbia, New York imposes a cap on interest rates, making it impossible for payday lenders to be profitable. State regulators—recognizing the danger posed by these predatory loans—have been aggressive about preventing payday lenders from using loopholes like operating from tribal lands or over the internet. The result is that we have been able to keep most unscrupulous lenders out of New York.
Some illegal lending still happens, but law enforcement has been confronting it aggressively. This is in stark contrast to states like Missouri and Wisconsin that have a taken a hands-off approach. In those states and others like them, payday-lending storefronts outnumber Starbucks and McDonald’s combined.
The new rules proposed by the Consumer Protection Financial Bureau will not preempt state laws, but payday lenders and their well-paid lobbyists are already arguing that New York should roll back its strong protections to be consistent with the new federal guidelines, which are weaker than the protections provided by New York law.
That is why, before the final version is released, the CFPB must strengthen its rule to provide states like New York with tools to keep abusive payday loans out. For example, CFPB should stand behind tougher state laws by stating that efforts by lenders to circumvent these laws would be considered an unfair deceptive practice, subject to both state and federal sanctions.
Why all the concern? Because payday loans make many borrowers worse off, and the primary victims are often people whose financial lives are shaky to begin with. A typical payday loan is supposed to last no more than two weeks. But the business model of payday lending depends upon borrowers rolling over their loans multiple times, resulting in more and more interest payments and fees. While borrowers struggle to pay down the interest charges and the fees, the principal remains untouched. It frequently takes the better part of a year to pay off what was supposed to be a short-term loan.
And the interest rates on payday loans are ruinous. Beyond the aforementioned 300% average, we have seen annual interest rates surpass 1,000%.
Payday lenders claim that these rates are necessary because low-income borrowers represent a high risk. Of course, risk must be factored into lending, but we dispute the idea that lenders cannot make a profit without a business model that traps many borrowers in debt.
Alternatives exist. We know of one startup that offers small-dollar loans through employers as a benefit to their employees. Loans are never more than 8% of the employee’s paycheck, and the loan is repaid with small payroll deductions spread out over 12 months at an interest rate of no higher than 25%. We have both been involved with such efforts. Credit unions often offer payday loan alternatives. Some faith-based loan funds offer loans with no interest at all.
States approach consumer safety differently, and a national ban on payday lending is not currently in the offing. So in the parts of America where payday lending is lightly regulated or left alone, federal guidance on how the industry should operate in order to protect borrowers is essential. But the CFPB and our state legislators should make sure that this step forward in the rest of the country does not unintentionally knock consumers in New York one step back.
Rabbi David Rosenn is executive director of the Hebrew Free Loan Society, a microfinance organization that provides interest-free loans to low- and moderate-income New Yorkers. Mark Levine represents Manhattan in the City Council. He founded Neighborhood Trust Federal Credit Union, which helps low-income families in Upper Manhattan gain access to financial services.
This article was originally featured in Crain’s New York Business.