When people who lack access to mainstream financial services, primarily the unbanked or underbanked, need an infusion of cash, they often take out payday loans. Payday loans are typically marketed as two-week credit products for temporary needs, with annual interest rates set at around 400% and often more. Payday loans, which are advertised as quick way to obtain needed funds, appeal to disadvantaged members of society for many reasons. Payday loan stores are everywhere, with more locations than all of the McDonalds and Starbucks locations combined, and practically anyone can walk into a payday loan store broke and walk out with $300 cash in a matter of minutes.
Although if paid back within a two-week period, borrowers can avoid the 400% interest, according to the latest Pew Charitable Trust report on payday lending, Payday Lending in America: How Borrowers Choose and Repay Payday Loans, the people who borrow payday loans are not prepared to pay them back in such a short period.
According the report, 86% of borrowers cannot afford to repay the average payday loan on time. The first Pew Charitable Trust report on payday lending, Payday Lending in America: Who Borrows, Where They Borrow, and Why, found that 12 million Americans use payday loans annually, spending a total of $7.4 billion. According to that report, the average borrower takes out eight loans of $375 each per year and spends $520 on interest. The five groups of people most likely to use payday loans are people without a four-year college degree, home renters, African Americans, people earning below $40,000 per year, and people who are separated or divorced.
The two Pew reports show the extent to which the payday loan industry attracts vulnerable customers: people who are financially desperate, people who are ill-equipped to understand the ramifications of payday loans, and people who are ill-equipped to repay payday loans in time. Payday loans are bad products, and they exist only because struggling people feel like they have nowhere else to turn.
So who is at fault? Obviously the payday lenders themselves are engaging in morally reprehensible behavior, but the fact is that these lenders are enabled by mainstream banks.
Although the major banks are not literally distributing payday loans, they are an integral part of the payday lending market. Banks such as Wells Fargo, U.S. Bancorp, and JPMorgan Chase bankroll the payday lending industry providing more than $2.5 billion in credit to the payday lending industry. These banks earn approximately $70 million annually lending money to payday lenders.
In addition, banks profit directly from payday loan borrowers. Many banks including JPMorgan Chase, Bank of America, and Wells Fargo authorize payday lenders to withdraw funds from borrowers’ bank accounts. Given what we know about the population that obtains payday loans, it is not surprising that when banks provide payday lenders access to borrowers’ bank accounts to repay the loans, there are usually insufficient funds available. As a result borrowers’ accounts are often overdrawn. In fact, according to the latest Pew report, 27% of payday loan borrowers overdrew their accounts. To add insult to injury, since paydayloans are rarely one-time purchases—the average borrower takes out eight per year—these fees help trap people in a cycle of debt. Even in states where payday loans are illegal, consumers that used online payday lenders are faced with overdraft fees from their banks due to online payday loans. In 2012 alone, banks earned $31.5 billion on overdraft fees, charging a median fee of $29 per overdraft.
Thus banks are benefiting just as much as payday lenders.
There is one piece of recent good news for consumer advocates. Two days after the publication of a front page New York Times article exposing these unfair overdraft practices, Jaime Dimon, the CEO of JPMorgan Chase, said that he would change how the bank deals with internet-based payday lenders that automatically withdraw payments from borrowers’ accounts. Additionally, as discussed in a previous blog, the Stopping Abuse and Fraud in Electronic (SAFE) Lending Act of 2013 (S. 172) was recently reintroduced. This bill attempts to address the issue of online lenders who have designed abusive products in order to evade state consumer protections.
To become part of the effort to stop predatory lending in Illinois, join the Illinois Asset Building Group.