Tom: Good morning, Mellody. You have a very important topic for us this morning – payday loans.
Mellody: It is a very important subject, Tom. Making sure that we talk about payday loans and other predatory lending schemes is crucial, because they are built to prey upon the most vulnerable individuals in a community. With the promise of easy access to cash for anyone, regardless of credit history, the industry is built on the backs of the working poor, and those experiencing bouts of financial distress.
Tom: So let’s start off by defining predatory lending.
Mellody: By definition, predatory lending is lending that benefits the lender, not the borrower. It consists of any lending method that ignores or actively hinders the borrower’s ability to pay the loan back, by imposing unfair or abusive loan terms on a borrower.
These lending tactics often try to take advantage of the borrower’s confusion or lack of understanding about loans, terms or finances in general. But predatory lending also encompasses any practice that convinces a borrower to accept unfair terms through unscrupulous actions for a loan that a borrower doesn’t need or doesn’t want. Predatory lenders tend to target individuals who are poor, elderly, or less educated, as well as minority and immigrant communities.
Tom: That really is awful. Is the government doing anything about this?
Mellody: For years, many states and cities have tried to rein in these payday loans and other predatory lenders that are a $46 billion a year industry. The industry is a slippery target, however. Using loopholes and exploiting the grey areas within these regulations, many of these lenders have been able to slightly shift their practices or alter their products in a minor way in order to get around state laws targeting them.
However, we have seen things look up recently. In March, for the first time, the federal government has jumped into the ring to try to place limits on these lenders.
Last month, the Consumer Financial Protection Bureau, released draft rules that are expected to curb the number of loans, address credit backed by car titles and some installment loans that have lifespans beyond the traditional two-week payday loan.
For example, certain installment loans that have interest rates above 36 percent, are likely to be covered by the rules. In another example, lenders would be required to assess a customer’s income, other financial obligations and borrowing history to ensure that when the loan comes due, there will be enough money to cover it. The rules would affect certain loans backed by car titles and some installment loans that stretch longer than 45 days.
Tom: That is good news. What else do our listeners need to understand about predatory lending?
Mellody: The biggest thing that you need to know is that it is best to simply avoid these loans. Even in the event of an emergency, when you use these loans, you are very likely to cause big financial headaches for yourself. The reason for this is because of the interest rates that these lenders charge. Usually, their rates are expressed in dollar amounts, such as $15 for every $100. That seems high already, right? But what most people do not take into account is the span of the loan. Lets do the math. If that is a two-week loan for $100, and your fee is $15, the interest comes out to $1.07 per day. But when you extrapolate that expense out to a year – $1.07 x 365 days = $391 – the annual percentage rate on that loan is 391 percent!
If you are in a pinch, there are some other options out there as well. First, try credit unions. They are usually based in the communities where they are located, and they do often have some reasonable options for small loans. If you are really in a pinch, you might consider a cash advance from a credit card. It’s not a great deal, because your credit card may charge 25 percent or 30 percent interest, but it is better deal than paying 300 percent to 500 percent interest. And finally, I know it’s tough, but if it is a real emergency, consider borrowing from family or friends. You may even consider offering to pay some of the money back through bartering or providing services such as cooking meals or doing yard work. Just remember, it is better to avoid these loans all together, because the convenience is not worth it.
Tom: Mellody, any final thoughts?
Mellody: One last thing our listeners need to keep in mind, Tom. We know that nearly 70 percent of borrowers use the loans to cover basic expenses; people are trying to make ends meet. But often times, in doing this they are simply placing themselves in more danger. Going after people on precarious financial footing is part of the predatory cycle, and it explains how so many small loans can spiral out of control.
If you are in this situation, or you know someone who is, it is best to see a credit counselor to help you right the ship. The government is trying to place limits on this practice, but it is best to be safe, avoid these lenders, and seek assistance if you are in choppy financial waters.
Mellody is president of Ariel Investments, a Chicago-based money management firm that serves individual investors and retirement plans through its no-load mutual funds and separate accounts. Additionally, she is a regular financial contributor and analyst for CBS News.