As this report illustrates, payday and title lenders prey on the most vulnerable Alabamians, trapping them in a nightmarish cycle of debt when they already face financial distress. They typically operate in low-income neighborhoods and lure unsuspecting borrowers with advertisements offering easy access to cash. They target down-on-their-luck customers who have little ability to pay off their loans but who trust, wrongly, that the lenders are subject to regulations that protect consumers from usurious rates and unfair practices.
These predatory lenders have no incentive to act as a responsible lender would. They have shown no desire to assess borrowers’ ability to pay; to encourage consumers to borrow only what they can afford; to explain loan terms in detail; to extend loan terms to encourage on-time repayment instead of rollovers; or to offer financial education or savings programs in conjunction with the loan.
Instead, their profit model is based on extending irresponsible loans that consumers cannot possibly repay on time. Policymakers must step in to ensure that these lenders can no longer drain needed resources from our most vulnerable communities.
The following recommendations should serve as a guide to lawmakers in establishing much-needed protections for small-dollar borrowers:
LIMIT ANNUAL INTEREST RATE TO 36%
An interest rate cap is necessary to limit the interest and fees that borrowers pay for these loans, especially considering that many of them are in debt for about half the year. A rate cap has proven the only effective way to address the multitude of problems identified in this report, as it prevents predatory payday and title lenders from exploiting other loopholes in the law. Many states have enacted similar caps,29 and Congress has enacted such a cap for loans to active-duty military families.30
ALLOW A MINIMUM REPAYMENT PERIOD OF 90 DAYS
As the stories in this report show, a period of two weeks or a month is too short to provide a meaningful opportunity for repayment. The Federal Deposit Insurance Corporation (FDIC) noted after its pilot program in affordable small-dollar loans that a 90-day loan term is the minimum time needed to repay a small-dollar loan. In fact, this was the feature that most bankers in the pilot linked to the success of their small-dollar loan program.31 Another option for extending the loan term is to enact a mandatory extended repayment plan, which would allow all borrowers the option to extend their payments over a longer period rather than make one lump-sum repayment. However, policymakers must ensure that borrowers are informed of this option and can take advantage of it.
For title loans, an even longer repayment period may be necessary, depending on the amount of the loan. A longer loan term is necessary to prevent lenders from asking for the full amount of the loan after each 30 day period, despite telling consumers they will be able to make loan payments.
LIMIT THE NUMBER OF LOANS PER YEAR
A limit on the number of loans per year ensures that the product is reserved for the industry’s stated purpose of short-term, occasional use for borrowers facing unexpected budgetary shortfalls. The FDIC has also recognized the need to limit the amount of time borrowers are in debt with these high-interest loans and has instructed banks engaged in payday lending to ensure that payday loans are not provided to customers who are in payday loan debt for three months of any 12-month period.32 This loan cap should be accompanied by increased disclosure of the maximum number of loans, as well as a longer loan term or extended repayment plan so that borrowers will not default when they reach their limit.
ENSURE A MEANINGFUL ASSESSMENT OF BORROWER’S ABILITY TO REPAY
A borrower’s ability to repay should be considered in both payday and title loans. Any assessment of ability to repay should consider both a borrower’s income and additional financial obligations.
CREATE A CENTRALIZED DATABASE
A centralized database is necessary for enforcing the loan limits recommended in this report and those already enacted into law. It also facilitates reporting of loan data so that lawmakers and the public can better understand who uses these loans.
BAN INCENTIVE AND COMMISSION PAYMENTS FOR EMPLOYEES BASED ON OUTSTANDING LOAN AMOUNTS
The compensation model for many predatory lenders incentivizes employees to encourage borrowers to take out larger loans than they can afford and to continue rolling over these loans at the end of each loan period. This incentive system should be eliminated to prevent employees from coercing borrowers to remain indebted for months and instead encourage responsible lending and borrowing.
PROHIBIT DIRECT ACCESS TO BANK ACCOUNTS AND SOCIAL SECURITY FUNDS
Payday lenders’ direct access to the bank accounts of borrowers must be prohibited, as it allows lenders to evade protections for Social Security recipients and coerces borrowers to repay their payday loan debts before satisfying any other obligations. Congress recognized the abuses that can stem from this direct access and, for active-duty members of the military and their dependents, has prohibited lenders from using a check or access to a financial account as security for the obligation.33
PROHIBIT LENDER BUYOUTS OF UNPAID TITLE LOANS
Lenders must be prevented from buying a title loan from another lender and extending a new, more costly loan to the same borrower. In order to encourage responsible lending, policymakers should not allow a lender to extend more money to consumers who have demonstrated an inability to repay a smaller loan.
REQUIRE LENDERS TO RETURN SURPLUS OBTAINED IN SALE OF REPOSSESSED VEHICLES
It is fundamentally unfair for lenders to obtain a windfall by retaining the full sum obtained from the sale of a borrower’s car after repossession. Requiring lenders to return the surplus will also temper the lenders’ incentive to repossess the car rather than work with a borrower on a repayment plan.
CREATE INCENTIVES FOR SAVINGS AND SMALL-LOAN PRODUCTS
The FDIC pilot program, which studied how banks could profitably offer small-dollar loans, was helpful in determining a template for affordable small-dollar lending. Additionally, the FDIC stated that Community Reinvestment Act examiners may favorably consider small-dollar loan programs when evaluating the institutions’ lending performance. Although the regulation of payday and title lenders should spur affordable lenders to enter the market, additional incentives should also be developed to encourage responsible products targeted at low-income consumers.
REQUIRE FINANCIAL EDUCATION AND CREDIT COUNSELING
Policymakers should ensure that the communities targeted by predatory lenders are also made aware of affordable small-dollar loan options and savings programs. This could include requiring payday and title lenders to distribute an approved list of credit counselors, alternative credit options and other emergency assistance options to consumers before they are given the loan agreement to sign, and providing financial education courses in low-income communities.