The Changing Face Of Short-Term Lending

About a year ago, the CFPB, which now goes by the BCFP, dropped the final version of its payday lending regulations. This followed a nearly five-year-long process that included debates, discussions and a few out-and-out screaming contests.

At its core, the new set of rules restricted a lender’s ability to continually collect fees on small loans by more tightly controlling how often, and how much, customers can borrow.

The regulations were designed to curb the main complaints leveled by consumer advocates: CFPB data showed that nearly a quarter of borrowers rolled over their loans at least six times, leading to total fees that exceeded more than the size of the initial loan.

“Lenders actually prefer customers who will re-borrow repeatedly,” then-CFPB Executive Director Richard Cordray said after releasing the new regulations last year. “These protections bring needed reform to a market where far too often, lenders have succeeded by setting up borrowers to fail.”

Being compliant with these new regulations meant big changes to the payday lending process, including testing requirements to confirm a borrower’s ability to repay a loan on time while still meeting day-to-day expenses. The rules also limit the number of loans that can be made in quick succession to three individual borrowers. Lenders who do not want to deal with the more complex underwriting requirements can elect to offer loans lower than $500 or to change their payday loan products into installment loans.

Payday loan opponents cheer its success. Payday loan revenues have plummeted from $9.2 billion in 2012 to $5.3 billion in 2017, and the number of payday storefronts have shrunk from 24,043 in 2007 to 16,480, according to the CFPB.

But then came the Trump administration and the changing of the guard at the CFPB.

The New Terrain

About a month after the payday lending regulations were dropped, two changes happened that changed the payday lending landscape, and the Office of the Comptroller of the Currency (OCC) revisited its stance on banks and short-term, small-dollar loans.

In early November of 2017, Richard Cordray left the CFPB and Mick Mulvaney became the interim director. Within two months, Mulvaney announced (in January of 2018) that the CFPB wanted to revisit the payday lending regulations with an eye toward their revision. Reports suggest that the agency is moving ahead with redrafting those rules, with revisions to be released in February of 2019. The new regulations are set to go into effect in August of 2019, though how much or how little they will resemble the current rules remains unknown.

The OCC also revisited its stance on banks and these consumer lending products. In 2013, the office strongly discouraged short-term lending as banks placed strict limitations on what could be offered to customers based on their credit history.

Those rules were formally rescinded in 2017, and then followed by new guidance from the OCC earlier this year, actively encouraging banks to offer responsible short-term, small-dollar loans to their customers. And at least one major bank seems to have been adequately encouraged. U.S. Bank is rolling out – in limited form, for account holders only – a short-term lending product with more favorable terms than one is likely to encounter at the average payday lender.

The product is called Simple Loan, and as its name implies, it is designed to be pretty straightforward. Consumers can borrow any dollar amount from $100 to $1,000, and then have to pay back the loans in three payments over three months. The bank charges a $12 fee for every $100 borrowed, and deducts payments from the consumer’s checking account via autopay. The charge goes up to $15 for every $100 borrowed if a customer repays the loan outside of the autopay arrangement. For example, a consumer who borrows $300 will pay $336 over the course of three months.

And while it remains to be seen whether other FIs would want to follow in U.S. Bank’s footsteps, there are several very good arguments to be made for why they might want to, since the need for and the use of short-term lending products may be a lot more mainstream than otherwise thought.

The New Financial Instability

Most people have a particular stereotype of the payday lending customer. They might be partially wrong.

There are customers with sub-600 credit scores who have been shut out of the credit markets due to chronic delinquencies, and borrow money from payday lenders, pawn shops and family and friends. That profile closely correlates to the “Shut Out” consumer profile described in the PYMNTS/Unifund Financial Invisibles Report. Those customers tend to be closest to what most people picture when they think about the short-term lending market.

What that report also identified is a much different customer – one who appears on the surface to be more financially stable. We call them the “Second Chances.”

Second Chances are consumers who have had a financial setback in the past, but are now working their way back into the financial system – usually because they have the earnings capacity to take on debt, according to the PYMNTS/Unifund report. On average, they earn over $60K a year, tend to own their own homes, have credit cards (two-thirds), have college degrees and have bank accounts (over 90 percent).

Shut Outs and Second Chances are among the borrowers chronicled by the report; the remaining two are the No Worries group and the On the Edge group. No Worries are the most financially secure persona in the mix: They earn the most money per year, have the highest rate of homeownership, have the highest rate of educational attainment and tend to utilize credit liberally, but responsibly. They don’t tend toward delinquent balances, have credit scores in the mid to high 700s and have a very strong track record of paying off what they buy and saving their earnings.

In many ways, Second Chances look to be the most like No Worries on paper – particularly in terms of homeownership, education, income and credit card use.

But under the hood, the picture is not so strong. Over 70 percent admit they have paid a bill late during the past year, and nearly 80 percent report living paycheck to paycheck, despite their higher income. About 13 percent report using personal loans of some flavor in the last year, as well as payday loans, online lenders, MoneyGram, pawn shops and RushCards. Pawnshops turned out to be a particular favorite in this group – 61 percent of Second Chances used a pawnshop loan in the last year.

And, it seems, Second Chances know that perhaps their second chance is going sub-optimally, with a majority in the demographic expressing pessimism regarding their present and future statuses.

“The obvious conclusion to draw is that they are living beyond their means, or at least that their income is not keeping up with their expenses,” Unifund VP Steve Ashbacher noted in an interview with Karen Webster. “The problem is that just opens up a gigantic can of worms – how can that be? How do some high earners have expenses that are outpacing their incomes so rapidly that they are visiting pawn shops in some cases to get access to funds?”

Where We Go From Here 

Proponents of the regulations say they are an important protection for highly vulnerable consumers who are likely to get drawn into a nearly inescapable cycle of debt. Payday loans and other forms of short-term lending do not help consumers – they just offer them a way to turn a short-term financial problem into a more expensive, long-term problem.

Opponents of the regulation continue to argue that the CFPB rules aren’t an attempt to regulate payday lending, but to ban it through a regulatory structure that will more or less force eight out of 10 lenders out of business, and deny people credit access for the short duration of time that they need it.

The typical duration of a short-term loan is 60 days, and the average amount borrowed is under $400. The 78 percent of borrowers who like and need the products, have no long-term difficulty using them and use them responsibly would be sorry to see them go.

The answers aren’t easy – and won’t get easier as the environment continues to evolve, and to perhaps include a wider swatch of customers.

But then, the discussion is far from over, as the latest version of the rules is currently under construction.

We’ll keep you posted on what comes next.