Taking some risk out of payday loans

Consumer advocates have long battled with companies that offer high-interest “payday loans” over the lenders’ proposals to increase the maximum amount a person can borrow. Now, a group of those advocates is taking the offensive, pushing a bill that would fix two fundamental problems with payday lending as it’s practiced in California. The point isn’t to end that form of lending — as the widespread use of the service shows, it responds to a real need — but to stop the loans from becoming a debt trap for desperate consumers.

Payday loans are easy to obtain, requiring little more from borrowers than a paycheck stub and a checking account. And although the number of outlets has declined, there’s no shortage of lenders in the state. According to recent statistics from the California Department of Corporations, there were more than 2,100 storefronts offering payday loans in 2011. For low-income communities and credit-impaired consumers who pose more risk than banks want to take, payday lenders can be the most convenient and reliable source of extra cash.

The main drawbacks of these loans are that they have to be repaid all at once and in relatively short order, typically within two to four weeks. They also carry a fee of up to 15% that gets deducted immediately from the amount of the loan, which equates to an average annual interest rate of more than 400% — a particularly high price to pay when banks are charging especially low interest rates for conventional loans. That’s why payday loans are mainly for consumers who can’t take advantage of less costly forms of credit, such as credit cards or home-equity loans.

Yet these loans also are in high demand. According to the Department of Corporations, $3.3 billion worth of payday loans were issued in 2011 to 1.7 million customers, up from $2.6 billion in loans to 1.4 million customers in 2006. The average loan amount was $263, which isn’t far below the legal limit of $300, and only 2.2% of the loans had to be written off because they couldn’t be repaid.

Now for the most troubling statistic: Individual payday loan customers in 2011 took out an average of seven loans. This figure belies the industry’s claim that customers use the loans to get out of brief and unexpected financial jams. Instead, it suggests that many payday loan users are stretched so thin financially that a single loan doesn’t provide much help. Instead, they wind up going back again and again for advances on their paychecks, running up considerable fees in the process. Although state law limits borrowers to one payday loan at a time, there’s no practical way to prevent someone from taking out multiple loans from different lenders.

To try to stop people from getting caught in that kind of cycle, four consumer groups led by the Center for Responsible Lending are backing SB 515, sponsored by state Sen. Hannah Beth Jackson (D-Santa Barbara). The latest version of the measure would do two things. First, it would require lenders to give borrowers at least 30 days to repay loans. And second, it would diminish the debt-trap risk by barring people from taking out more than six payday loans in a year. The bill would make the limit enforceable by requiring an industry-funded database of payday loan borrowers. Without such a database, the state can’t enforce even the existing rule barring people from obtaining multiple payday loans at the same time.

Payday lenders complain that the rules would drive up their costs and, potentially, push them out of the market. If that were to happen, they argue, many Californians would be left at the mercy of unregulated lenders online. The goal of the bill isn’t so radical, however; it’s simply to ensure that payday lenders fill their intended niche. Payday loans aren’t designed to be a substitute for installment loans that let borrowers spread large costs out over a long period of time. Sadly, too many Californians are using them that way, which is why SB 515 is needed.