Nati Harnik/AP Images
- Payday lenders target Black and Latinx communities, setting up more stores in minority neighborhoods.
- But for those living paycheck-to-paycheck, predatory loans may seem like the only option.
- Fintechs offering small-dollar loans and early access to wages could prove a replacement for those in need of short-term cash.
- This article is part of a series called "The Cost of Inequity," examining the hurdles that marginalized and disenfranchised groups face across a range of sectors.
Payday loans are notorious for being a financial tool that prey on the less fortunate. But for many they still serve as a lifeline between paychecks.
Strip malls across the US are littered with payday lenders, advertising "EZ MONEY" and "CA$H NOW."
While the total number of payday lending shops has fallen over the past decade, it's still a sizable market. About 12 million Americans take out payday loans each year, according to Pew Charitable Trusts.
But thanks to increased regulatory scrutiny, and competition from new tech-focused competitors, payday lenders' days could be numbered.
Under a new administration, federal regulators like the Consumer Financial Protection Bureau (CFPB) are exhibiting a renewed focus on payday lenders, and could reinstate tighter underwriting rules revoked by the previous administration.
Payday loans create debt traps
Consumers typically borrow $375 from payday lenders, with fees averaging around $55, according to the CFPB. A $55 fee on a $375 two-week loan amounts to about 15% interest, a favorable rate compared to credit cards.
But when annualized, those terms amount to a 382% APR. More often than not, borrowers aren't repaying payday loans within the two-week terms, which results in a cycle of debt.
"We know that payday loans are typically short-term loans that are designed to create a long-term debt trap," Charla Rios, a researcher at the Center for Responsible Lending (CRL), told Insider.
Roughly 75% of payday lenders' revenue comes from fees generated from borrowers taking out loans more than 10 times a year, according to the CRL. In the 34 states that allow triple-digit interest rates - other states have enacted rate caps - fees cost consumers $4 billion each year.
Payday lenders are not required to assess a consumers' ability to repay. They also frequently require access to consumers' bank accounts to deposit the loan, then to debit it when it comes time to repay.
If the borrower doesn't have enough money in their checking account, that could result in several overdraft fees. Payday lenders can also sell unpaid loans to debt collectors.
Payday lenders are concentrated in minority neighborhoods
Much of the criticism aimed at payday lenders stems from the fact they are often most present in neighborhoods with higher concentrations of people of color.
"There's been research done both by the Center for Responsible Lending and a lot of other consumer advocates across the United States that constantly and continuously show that payday lenders have typically located their stores in communities of color," Rios said. The CRL conducted research in states such as California, Colorado, Michigan, and Florida.
A similar trend was found in Minnesota, according to a 2016 report: Neighborhoods that had payday lending stores within 2.5 miles have two times as many Black residents compared to the rest of the state.
And even when controlling for income, the CRL found that in Florida, there were more payday lending shops in high-income, high-minority communities, Rios said.
Regulators have gone back and forth on reigning in the payday industry
Regulators have analyzed payday lenders in recent years.
The CFPB issued a rule in 2017, the core tenants of which required payday lenders to assess a borrowers' ability to repay the loan, notify them before attempting to debit their bank accounts, and limit the number of times a lender could attempt to draw from a borrower's bank account.
The rule was set to take effect in August 2019, but was ultimately pushed to November 2020. The CFPB also revoked the underwriting standards around payday lenders having to assess a consumers' ability to repay.
But under a new administration, recent statements by the CFPB indicate the agency's renewed focus on payday lending.
"Years of research by the CFPB found the vast majority of this industry's revenue came from consumers who could not afford to repay their loans, with most short-term loans in reborrowing chains of 10 or more," acting director Dave Uejio wrote in a statement in March.
Uejio noted that the prior administration had revoked the underwriting rules that would address these consumer harms, and hinted at possible rulemaking in the future.
"The bureau believes that the harms identified by the 2017 rule still exist, and will use the authority provided by Congress to address these harms, including through vigorous market monitoring, supervision, enforcement, and, if appropriate, rulemaking," Uejio said.
Small-dollar loans and earned wage access offer an alternative
While payday loans fulfill a need for many, especially the unbanked and those with no or low credit, there are alternatives.
OppFi, which is going public via SPAC, is one such small-dollar lender. It's catered toward no or low-credit consumers, and offers loans from $500 to $4,000 at rates between 59% and 160% for terms as long as 18 months.
To be sure, those are expensive terms. But OppFi does try to refer its customers to cheaper, mainstream credit, first. For every loan application, OppFi offers to do a check on a consumer's behalf to see if they qualify a near-prime loan with traditional lenders. 92% of the time, applicants don't get any offers, OppFi CEO Jared Kaplan told Insider.
And OppFi's loans are meant to help its customers build credit, Kaplan said. Every payment applies to the principal balance of the loan, there are no fees, and OppFi doesn't sell its loans to debt collectors.
Earned wage access, where consumers can access funds they've already earned between paychecks, has also emerged in recent years, often marketed as an alternative to payday lending.
Many earne wage access players, like DailyPay and PayActiv, partner with employers to reach consumers. There are often fees associated with the product, but since these players are integrated into payroll systems, they're not directly debiting bank accounts that may have insufficient funds.
DailyPay, for one, found in a survey that 70% of users say they no longer have to take out payday loans, and 78% say that drawing on earned wages helps them avoid late fees. Payroll giant ADP is also building out earned wage access products.
There are drawbacks. For both third-party apps and integrated payroll providers, there are concerns around privacy. Employees might hesitate to use these products if they think their employers may be able to track that activity.
Other players in the market go directly to consumers, like Dave and Earnin. They operate on tipping models, where users decide how much to pay in addition to the wages they're drawing on, which can also be viewed negatively.
Tipping models have come under scrutiny from regulators. In 2019, the New York Department of Financial Services, alongside several other states, opened an investigation into earned wage access companies, specifically focused on tipping models, how they impact consumers' access to funds, and whether they constitute interest rates.
"One of the things to think about is that, when you incentivize people to tip, that can effectively equate to a high APR," Rios said.