Constraining Consumer Access Doesn't Solve the Payday Debt Trap
By Sasha Orloff
The Consumer Financial Protection Bureau, a government agency created after the 2008 financial crisis, is in the process of creating the first set of federal rules governing the short-term lending industry. Fearing that consumers are getting caught in "debt traps" -- borrowing money to pay back previous loans over and over again and never getting out of debt -- the agency is pushing for new regulations on small-dollar credit products like payday loans, title loans, and high-cost installment loans.
About 12 million Americans rely on short-term loans each year. Traditional banks have long ignored these customers, since banks are unable to underwrite such loans profitably.
But as written, the regulations could wipe out most -- if not all -- of the entire short-term lending industry, leaving consumers without any market alternatives. That's why the CFPB should scrap its regulations and instead focus its efforts on either addressing the problematic features of short-term lending products or creating a framework to encourage industry innovation.
If the CFPB enacts rules that essentially put the short-term lending industry out of business, what are consumers to do?
Some say they should save more.
But the Federal Reserve found that 47 percent of Americans couldn't pay for an unexpected $400 expense with savings or a credit card, but would be forced to sell a possession or borrow.
Others say they should ask family.
While some are fortunate enough to have friends or family members to turn to, many don't. Of those unable to meet a shortfall of $250, many do not have friends or family with money to lend.
Others suggest they should go to a bank.
But it's not profitable for banks to make short-term loans. With fixed costs of operations, underwriting, servicing, compliance and charge offs, banks cannot offer loans of a few hundred dollars.
The CFPB's new regulations would dictate exactly how lenders should assess a consumer's ability to repay a loan. This will disproportionately impact those who lack traditional income documentation, like the elderly, divorcees, minorities, and low-income Americans. These are the people the proposal is supposed to protect.
A better solution would allow short-term lenders to follow the guidance imposed from the credit card reforms, like reasonable income and expense verification, or a safe harbor for responsible lenders who have proven they can manage risk effectively.
The ideal framework would protect consumers by ending problematic practices, but keep credit flowing to responsible, hard-working Americans. Reasonable procedures for income and expensive verification, rules ensuring payments cover interest and reduce principal, and eliminating bad actors will go a long way to achieving the consumer protections the CFPB desires.
The CFPB's proposal would reduce access to credit, which would increase bankruptcies, lower credit scores, and force borrowers to turn to more expensive options with fewer consumer protections. It would stifle innovation and reduce choice for consumers who desperately need more, not fewer, options.
The CFPB should adopt a framework that incentivizes innovation and market alternatives instead of prescribing a one-size-fits-all mandate. It should work to expand access to credit in struggling, low-income communities, not restrict it.
Sasha Orloff is the CEO and co-founder of LendUp, a venture-backed startup that builds credit solutions for consumers who banks and traditional lenders can't help.
