If you need more evidence that payday loans can be a debt trap, look no further than today's report by the Consumer Financial Protection Bureau.
The agency found that 4 out of 5 payday loans are renewed or rolled over within two weeks after the end of their term. In half of these cases, the borrower renews the loan at least 10 times in a row.
And repeat borrowing may be more expensive than many borrowers may realize. Fees in 1 out of 5 renewed loans wound up exceeding the initial amount borrowed, the CFPB found.
"From this finding, one could readily conclude that the business model for the payday industry depends on people becoming stuck in these loans for the long term, since almost half their business comes from people who are basically paying high-cost rent on the amount of their original loan," Richard Cordray, director of the CFPB, said in a statement.
He said the agency is in the final stages of developing potential reforms.
A payday loan is a short-term loan, usually two weeks, and meant to be a emergency bridge between paychecks. Consumer advocates have long complained that the fees on these loans are exorbitant. The typical fee is $15 per $100 borrowed, which translates into an annual percentage rate of about 390 percent. Even so, an estimated 12 million Americans now use such loans, the CFPB says.
The CFPB looked at the one-year activity of borrowers taking out more than 12 million loans from storefront payday lenders in 30 states in recent years.
The CFPB doesn't break out borrowers by age. However, it said that 1 out of 5 borrowers paid on a monthly basis - a sign that they receive Social Security or other government benefits - and remained in debt for the entire year studied.
Elizabeth Costle, director of consumer and state affairs for the AARP Public Policy Institute, says payday lenders tend to like older consumers on Social Security because of the steady income stream.
"The problem is most people can't pay them off in two weeks or a month," Costle says. "They roll them over and they get more fees and more interest, and they get themselves into a debt spiral where they can't get out."
The Community Financial Services Association of America, which represents payday lenders that operate about 12,000 storefronts nationwide, says its polling shows that the vast majority of customers are happy.
The group represents about half the storefronts in the market and members are licensed by the states they operate in, says spokeswoman Amy Cantu. Members offer an extended payment plan at no charge for those who need more time to repay, although consumers are not allowed to take out another loan while in the plan, which is why some don't use it, she says.
Cantu says her group is working with the CFPB to address reforms.
The CFPB began taking complaints on payday loans in November, and so far, the number has reached several thousand, Cordray said.
It's unlikely the agency will eliminate such loans, though.
"Preserving access to small dollar loans does mean, after all, that some such loans should be available," Cordray said. "Our concern instead is that all too often those loans lead to a perpetuating sequence" of loans.
Some states have essentially banned payday lending by setting interest rate caps on short-term loans. This has not stymied online payday lenders that pitch loans on the Internet to residents of those states. These lenders get customers' bank information so they can move money in and out of the account.
The CFPB report dealt only with loans made by storefront operators, not online lenders. However, whatever reforms the agency does develop will likely incorporate ways to protect consumers from problems with online lenders, as well.
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