We set out today to discuss payday loans, and specifically find out just how bad payday loans are&8230, for both your credit and your wallet.
Payday loans are a popular topic on financial sites and blogs – you’d be hard pressed to find a site that hasn’t written about them yet, or at least formed an opinion – and DQYDJ isn’t immune. We’ve written about the economics of payday loans, and even discussed the liquidity considerations which lead borrowers to consider them as options.
So, today, let’s talk about payday loans from as neutral a position as we can, and look at some of the most latest news in the payday loan arena.
(And, if we writers mostly agree that payday loans are “bad”, let’s attempt to response just how bad payday loans truly are.)
The CFPB Studies the Payday Loan Industry
Recently, the CFPB or Consumer Financial Protection Bureau, a fresh independent agency under the Federal Reserve has been studying the industry.
Albeit the CFPB’s charter is a bit confusing (we’ve written about the confusion shortly before), it’s generally agreed the CFPB can make rules that tie financial institutions. They also take consumer complaints about financial institutions directly, and monitor and issue reports on markets and financial products.
Today, most relevantly, we’ll point you to a latest report they published on payday lenders (PDF warning). It’s the 2nd time they’ve studied the industry in depth, the very first effort dates to 2013, and you can see their original payday loan whitepaper in depth here (PDF warning, again).
And, yes, the stats are pretty grim – accounts they studied with identifiable payday loans paid an average of $Two,164 over the Legitimate months studied, and a whopping $185 in overdraft and non-sufficient fund fees to their banks. Of those fees:
“$97 on average are charged on payment requests that are not preceded by a failed payment request, $50 on average are charged because lenders re-present a payment request after a prior request has failed, and $39 on average are charged because a lender submits numerous payment requests on the same day.” CFPB Online Payday Loan Payments Report, April 2016
It’s a harsh industry, and a raunchy product. Albeit sometimes fee averages like the above $185 are due to a fat tail of bad borrowers, for payday loans the CFPB witnessed failed payments from harshly half of all borrowers . And, yes, there was a fat tail&8230, it’s just that the number of downright successful borrowers was only half of the population of payday loan borrowers:
How Bad are Payday Loans? Only half of borrowers successfully avoided fees from their banks.
“It Didn’t Go Through? Attempt it Again!”
Albeit arguments can be made from both sides for the above graph – it, of course, takes two to tango – there is one payday loan issuer practice which is particularly sketchy.
Termed &8216,re-presentment&8216, by the CFPB, it’s worth studying a bit more in detail. Let’s tackle what that means:
Definitionally, payday loan borrowers are among the lowest rated of the sub-prime borrowers. While payday loan issuers have slew to reaction for, borrowers often do not borrow loans with intent to pay them back. One thing lenders have done is to split payments into numerous requests, to attempt to recover at least some of a payment. Here’s how it would work:
Issue 1 ACH Request: $100
Issue Two ACH Request: $100
Issue Three ACH Request: $100
That’s fair enough, it’s better for an issuer to receive some portion of payment than none, as we can all agree.
However, consider this: if the very first one fails and the bank charges the borrower an overdraft fee&8230, should the lender keep pounding on the account and attempt to receive payment for the 2nd two requests?
Well, hopefully not – they should attempt again another day, since obviously something has switched. Turns out, while most lenders do give a bit of a grace period before issuing another ACH request, there is a petite but sizable number of requests that happen on the same day(!):
How bad are payday loans? Days inbetween initial failure of an ACH request and a retry, by outcome.
So, 5-7 days and 14 days are the most common retry dates, with Two weeks (I suppose to hit a 2nd payday) is the most common successful retry date. Note, too, the large spike in failures at Day Trio.
The 0 day pings – that concerns me, but I see that these 2nd ACH hits are often successful (if causing overdrafts). The thing is, most subsequent requests are going to fail – and this is the perverse cycle of payday loans, when you consider the fees that are racking up on the back end in the bank account.
&8216,0th’ day repayment requests are more common (gratefully) for successful ACH requests – which truly just speaks to the nature of the product. You also see a pattern of waiting for the 2nd payday, which usually occurs about Two weeks later:
How bad are payday loans? Days from Successful ACH Request to Subsequent Request
So Just How Bad are Payday Loans?
Payday loans pack an visible niche – subprime borrowers who need money before their next paycheck. Unluckily, there are some shady practices in the industry which can trap borrowers in a cycle of dependency – and sure, we recognize that the borrowers cause many problems as well.
If we’re estimating that half of borrowers successfully borrow with payday loans without having to pay a 2nd institution (his or her bank, for NSF and overdraft fees), that means that toughly $185*Two = $370 in fees is what the average failed borrower is paying.
It’s unfortunate, while it’s simplistic to suggest that payday lenders shouldn’t even exist, the people who take out payday loans (or their cousins – auto title loans) are often desperate without many other credit options to turn a Two week paycheck cycle into real liquidity.
It can be effortless to cast our eyes down on the industry when we have access to all sorts of forms of superior credit – from cards to HELOCS – but those just are uncommonly an option in the lowest of the subprime market. Payday loans and auto title loans pack an under-served niche – and totally eliminating the industry will drive borrowers to pawn shops and (as we’ve noted before) illegal lenders and loan sharks.
While some of the battle lines have already been drawn – the CFPB has proposed a framework to regulate payday loans – there are still a lot of players yet to take sides. We noted recently that (big fish on the internet) Google banned all &8216,payday loan’ ads (defined as having repayment dates of under 60 days or effective APRs over 36%) from the AdSense ecosystem – we’re not exactly sure what the solution is here. While repayment durations could be part of the solution, arbitrarily capping APRs doesn’t seem like the right budge (and what would an illegal lender charge? I doubt it would be 36.01%&8230,).
Reminisce that, at the end of the day, 50% of borrowers are entirely successful with the product – how can we clean up the industry without forcing them to a worse alternative?
So how bad are payday loans? Pretty bad&8230, but things could be worse.
Maybe you’ve got some ideas on how to improve the prospects for sub-sub-prime borrowers? Let’s hear them. How bad are payday loans, in your mind?