While the mainstream financial industry has faced a dizzying array of government and quasi-government regulations through most of the last one hundred years, non-bank financial products have, for the most part, evaded regulations. Catering to lower-income communities, payday loan storefronts and check cashing establishments have managed to justify their business models. The more desperate you are to pay your electricity bills and your rent before your power is turned off and you’re evicted, the more likely you are to willfully ignore the fact that the companies helping you are taking advantage of you in ways that a traditional bank would never be allowed to do.
The Consumer Financial Protection Bureau (CFPB) is now charged with recommending new regulations that go beyond retail banks, thrifts, investment banks, and credit unions into the murky world of non-bank financial products.
If you compare a short-term payday loan with a loan from a bank, you might see that the payday loan’s equivalent interest rate (APR) is 450% or even higher. Mortgages tend to be 3% to 7%, business and personal loans could be 5% to 10%, and credit cards are 10% to 20% unless you default. Anything higher, and the loan might be considered usurious. So how do payday lenders get away with charging 450% or more?
Well, these lenders frame what they charge as a flat or sliding fee, not interest. The loans are typically due in two weeks, the expected arrival of your next paycheck. It might not be fair to compare these fees with interest rates, because the borrower doesn’t hold onto the loan for a long time.
Or does he? There’s some evidence suggesting payday loans create a cycle; rather than paying off the loan when the next paycheck arrives, lenders offer an enticing deal to encourage borrowers to begin the next loan. The two-week cycle repeats.
The CFPB wants to hear from people who have had experiences with payday lenders. In order to get a good grasp on how non-bank financial products can and should be regulated, the organization is seeking comments from the public. What have been your experiences with payday loans? Feel free to share here on Consumerism Commentary, or tell the CFPB your story directly.
Updated March 7, 2012 and originally published January 24, 2012.