The CFPB’s New Payday Lending Rule is a Big Win for Socially Responsible Lending

opploans-affects-of-CFPB-payday-loans

Payday and title lenders will be tasked with making sure their customers can actually afford their products.

Last week, the Consumer Financial Protection Bureau (CFPB) finally announced a new rule aimed at curbing predatory payday debt traps. The rule marks a large step forward for the bureau’s attempts to regulate the payday and title lending industries and to protect vulnerable consumers.

“The CFPB’s new rule puts a stop to the payday debt traps that have plagued communities across the country,” said CFPB Director Richard Cordray in a press release. “Too often, borrowers who need quick cash end up trapped in loans they can’t afford. The rule’s common sense ability-to-repay protections prevent lenders from succeeding by setting up borrowers to fail.”

“Only time will tell if these “full payment tests” will lower the number of full payment loans given to those who can’t pay them back,” says finance writer Jen Smith (@savingwithspunk). “Someone will eventually find a way to manipulate it for their gain but I think it’s a step in the right direction and a sign the CFPB is still working to protect consumers.”

So, okay, awesome. But what does all of this actually mean?

Let’s break it down, shall we?


What are payday and title loans?

The new rule primarily affects payday loans and title loans, but it will also apply to deposit advance products and certain longer-term loans (up to 45 days) that feature “balloon payments” towards the end of the loan’s term.

If you’re not familiar with payday and title loans, then we’ll give you a brief refresher:

Payday loans are short-term, small-dollar personal loans. They usually have principals of a few hundred dollars, and the average length of their repayment term is only two weeks. Payday loans are no credit check loans, which means the lenders do not check a customer’s credit score during the loan application process.

The loans are designed to be paid back all at once, oftentimes through a post-dated check that the customer gives to the lender when the loan is issued or through a debit agreement wherein the lender can automatically withdraw the funds from the customer’s account.

If a customer can’t pay the loan back on time, they might be given the option to roll the loan over (extending the due date for an extra fee) or taking out another loan immediately after they’ve paid the first loan off.

Because payday loans charge interest over such a short repayment period, their annual percentage rates are astronomical compared to traditional loans. While their rates may vary, they’re often in the neighborhood of 300 percent or even higher!

Title loans are another kind of short-term loan that use the borrower’s car title as collateral. If the borrower cannot pay the loan back, the lender can seize their car and sell it in order to make up its losses.

Because they’re secured by collateral, title loans have much higher principals than payday loans. However, they are also built to be paid back all at once—a structure that’s known as “lump sum repayment.”

The average term of a title loan is only a month, but the average interest rate is 25 percent, which means that their average APR is 300 percent! If a borrower cannot pay their loan back, they might be forced to extend their loan, again and again, each time racking up additional costs without ever getting closer to paying down their original principal.

When the CFPB talks about the payday debt trap, they’re talking about situations like that.

The CFPB’s rule centers around the “full payment test.”

Payday and title loans are bad credit loans, which means that they’re aimed at people with low credit scores. These are folks who often have low incomes and little-to-no life savings, and their bad credit scores have cut them off from borrowing options at traditional lenders. When they encounter a financial emergency or find they can’t make ends meet, they see payday and title loans as possibly their only choice.

In situations such as these, it might seem like a blessing to them that payday and title lenders do not check their credit scores or their ability to repay their loan. Doing so might lead the lender to deny the customer’s application.

However, the CFPB sees things a little bit differently. They believe lenders should be checking a customer’s ability to repay their loan the first time—without rolling it over or reborrowing. That’s what their new rule is going to make lenders do.

Here’s how the CFPB’s new “full payment test” rule will work

The CFPB’s full payment test will require that lenders determine whether a customer can afford to repay their loan while also affording their other major financial obligations, including living expenses.

  • For payday and title loans that require lump sum repayment, the CFPB is defining full payment as “being able to afford to pay the total loan amount, plus fees and finance charges within two weeks or a month.”
  • For longer-term loans with balloon payments, the CFPB is defining full repayment as “being able to afford the payments in the month with the highest total payments on the loan.”
  • Lenders will be required to “verify income and major financial obligations and estimate basic living expenses for a one-month period—the month in which the highest sum of payments is due.”
  • The rule will also cap the number of loans that can be taken out by a borrower “in quick succession” to three.
  • Once a borrower has reached their third loan, the CFPB’s rule will mandate a 30-day “cooling-off period” before they can take out another loan.

Lenders can skip the full payment test if they offer a  “principal pay-off option.”

The CFPB will offer an exemption from this full payment test for certain short-term loans if the lender offers customers a “principal pay-off option.” This option is designed to get consumers out of debt gradually over time—more like traditional installment loans.

  • If a customer can’t pay their loan off on time, they will be given the option of paying it off over two subsequent loans, each with a smaller and smaller principal amount.
  • The customer will have to pay off at least one-third of their original balance with each loan.
  • The rule will be restricted to loans with principals of $500 or less.
  • These loans cannot use a car title as collateral or be structured as open-ended lines of credit.
  • The lender is prohibited from offering this option over more than three loans.
  • The rule also prohibits the lender from offering this option to a customer “if the consumer has already had more than six short-term loans or been in debt for more than 90 days on short-term loans over a rolling 12-month period.”

Some lenders and loans will be exempt from this rule.

The CFPB does carve out some space for lenders whose loan volume is either very small or who are already following guidelines meant to protect customers from predatory payday lending.

According to the CFPB’s press release, “These are usually small personal loans made by community banks or credit unions to existing customers or members.”

Lenders will be exempt if:

  • They offer “2,500 or fewer covered short-term or balloon-payment loans per year.”
  • They derive “no more than 10 percent of its revenue from such loans.”
  • They are offering loans that “generally meet the parameters of “payday alternative loans” authorized by the National Credit Union Administration.”

The rule also “excludes from coverage certain no-cost advances and advances of earned wages made under a wage advance program.”

The rule institutes a “debit attempt  cut-off”

This last feature of the CFPB’s new rules involves a lender’s attempts to continually debit a customer’s bank account for the amount owed.

The reason for this is simple: If a person is unable to repay their loan, repeated debits on their account will only rack up additional bank fees and could even lead to them losing their account altogether.

This section of the rule applies short-term loans, as well as any longer-term loan with an APR above 36 percent. It has two main features:

  • After two straight unsuccessful debit attempts, a lender must stop debiting the account until they get a new authorization from the customer.
  • If a lender is going to debit a customer’s account “at an irregular interval or amount”, they must first give them written notice.

“The rule is a great step forward in protecting consumers but we still have room to grow,” says Smith. “I suggest people never give a creditor your debit account information because they will not stop debiting your account until they’re paid in full. The debit attempt cutoff rule will save consumers a lot of fees associated with this problem.”

So what happens now?

Well, that’s a tricky question, isn’t it? The rules won’t fully take effect for 21 months—which means mid-2019. Between now and then, a lot could change. There could be lawsuits, for instance, or there could be attempts by the payday lending industry to compromise with the CFPB in return for some relief from regulation.

Director Richard Cordray’s terms will be up in 2018 before the majority of these rules are in effect. He was an Obama appointee, while his successor will be appointed by Trump. It’s safe to say that whoever ends up replacing might have fairly contrary views to those held by Cordray.

Certain corners of the payday lending industry are predicting a mini-collapse if these rules take effect. They claim razor-thin profit margins that won’t be able to withstand the burdens that these regulations place on them.

The biggest worry with this new rule is that customers for whom subprime loans are their primary access to credit will find themselves cut off entirely.

However, the biggest hope is that financial institutions of all sorts will rise to the occasion and start offering better, more affordable, more socially responsible products to customers with not-so-great credit.

Only time will tell, but as a company that is already offering people with poor credit a safer and more affordable alternative to predatory payday loans, all of us here at OppLoans are pretty dang optimistic.

What do you think about the CFPB’s new rule? We want to know! You can email us or you can find us on Facebook and Twitter

Visit OppLoans on YouTube | Facebook | Twitter | LinkedIN | Google+


Contributors
Jen Smith is a personal finance and debt payoff expert. She has been featured on Student Loan Hero, The Penny Hoarder, and AOL Finance. Her website is SavingWithSpunk.com

How to Money, Episode 6: What is a Payday Loan?

How to Money, Episode 5: What is a Payday Loan?

It’s October, which means it’s time to get a little scary. That’s why our new episode of How to Money is focused on one of the scariest financial products there is…

Payday Loans!

What’s a payday loan?

Payday loans are a type of short-term personal loan. They are almost always no credit check loans, which means that the lender won’t check your credit score as a part of your loan application.

Payday loans come with very short repayment terms—averaging only two weeks in length—and APRs that are ridiculously high—even in comparison to other kinds of bad credit loans.

If you’re not careful, a payday loan could trap you in a cycle of debt. We’ll talk more about that below.

Due to their short terms, high rates, and the higher likelihood that borrowers will become trapped by their debt payments, payday loans are generally considered to be a form of predatory lending.

How do payday loans work?

Payday loans are small-dollar loans, usually around $300-400. In contrast, the average personal loan balance in 2017 was $7,603, according to TransUnion.

With a traditional payday loan, the only thing you need to secure the loan is a postdated check for the amount you borrow, plus interest, that you give to the lender. They then cash the check on the loan’s due date.

(Many payday loans nowadays are online loans. Online payday lenders often opt to automatically withdraw the funds directly from your bank account.)

The idea behind payday loans—with the short terms and low principals—is that they are only supposed to last you until your next payday. But the reality is something different and is something much, much scarier.

Let’s say you take out a 14-day payday loan with an interest rate of 15 percent. Sounds reasonable right?

Well, that loan’s interest rate doesn’t look so good when you compare it to the rates for other, longer-term loans.

The best way to measure a loan’s cost in comparison to other loans is to measure its annual percentage rate or APR.

Now, remember, that payday loan’s 15 percent interest rate only applies to a period of 14 days. If you measure how much it would cost over the course of one year, you get an APR of almost 400 percent!

But is that what your typical payday loan looks like? Well, if you believe this 2013 study from the Consumer Financial Protection Bureau (CFPB), then, yeah, that’s exactly what it looks like. They may not be as expensive as credit card cash advances, but they’re still way more expensive than your standard personal loan.

It’s those high APRs and short repayment terms that can lead many payday loan borrowers to get trapped in a dangerous cycle of debt.

(Many of these traits are also shared by title loans, another type of lending that’s widely thought of as predatory.)

The payday debt cycle.

There’s one other element that plays into the predatory debt cycle, and that’s lump-sum repayment.

Basically, payday loans are designed to be paid back all at once. This is different from installment loans, which are structured to be paid back in a series of smaller, regularly scheduled payments over time.

Combining lump-sum repayment with short loan terms means that many payday loan customers can’t pay their loan back on time.

Think about it. If you had two weeks to pay back 345 dollars, could you?

Some people then roll their loan over, extending their due date in return for paying more interest. With loan rollover, you get another two weeks to pay back the loan, but you have to pay the interest fee on an additional loan term. (It’s illegal in many states.)

Other people pay their loan back in full and then immediately take out a new one to cover other expenses. That’s because they paid it off using money that they needed to use on rent or their gas bill or on groceries.

In fact, a report [PDF] from the Pew Charitable Trusts found that only 14 percent of payday loan customers have the room in their monthly budget to pay off an average payday loan.

How often is this kind of stuff happening? Well, according to another CFPB study [PDF], over 80 percent of payday loans are rolled over or followed by another loan within 14 days.

Either way, people just keep extending or reborrowing their payday loans, racking up more and more interest, all the while never getting any closer to paying back the loan principal and actually getting out of debt.

That is how the debt cycle works, and that is why most people consider payday loans to be a form of predatory lending.

Here Are Your Takeaways

  1. Payday loans are short-term, small-dollar loans with very high APRs.
  2. Their payment terms often lead to loan rollover and reborrowing.
  3. They can easily trap people into an unending cycle of debt.
  4. Do not take out a payday loan.

If this your first time watching How to Money, you should check out our other How to Money episodes, where we cover secured loansthe debt to income ratio, and more! You can request topics for future How to Money episodes by emailing us or by shooting us a tweet at @OppLoans.

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5 Alarming Payday Loan Statistics

Payday Loan Statistics

Expert data on affordability, loan rollover, and APR that will make you think twice before borrowing.

You know payday loans are bad. But you might not have realized just how bad they can be.

That’s why we’ve gathered some stats, figures, and numbers to show you just how terrible and destructive payday loans are. Now come along with us on a magical journey through the dangerous world of payday debt.


1. APRRRRRRRGH

APR stands for annual percentage rate, and it’s a number that tells you what a loan will cost, with fees and interest, over the course of a year. This is important because it allows you to accurately compare different kinds of loans. Unlike most personal loans, which are paid back over a period of years, payday loans only have a two-week payment term, so it might seem like they’re more affordable than loans with longer terms, but that’s only true if you’re actually able to pay the loan back, with fees and interest.

(For more info about these dangerously deceptive numbers, check out our blog post “How (and Why) to Calculate the APR of a Payday Loan.”)

A study by the Consumer Finance Protection Bureau (CFPB) found that the average payday loan has an APR of almost 400 percent. And that’s a big issue, because…

2. Keep on rollin’

Another CFPB study found that over 80% of payday loans are rolled over or re-borrowed. That means the majority of these short-term, no credit check loans are being extended way beyond their two-week payment term. And the only reason someone would pay to extend a loan is because they aren’t going to be able to pay it back in time. And, unfortunately, there’s a decent chance that if you couldn’t pay off a loan in two weeks, you might struggle to pay off that loan plus a big fee two weeks after that. So payday loans get rolled over or re-borrowed over and over again, trapping the borrowers in a cycle of debt that they can’t escape from.

You can learn all the horrific details about the payday loan cycle of debt in our recent blog post.

3. Fret over debt

Speaking of a cycle of debt, that first CFPB study found that the average payday borrower takes out 10 loans per year and spends 199 out of 365 (or 366 if it’s a leap year) days in debt. In other words, they’re in debt more often than they aren’t. Obviously, there are “good” kinds of debt, like a well-maintained credit card, that can help build up your credit, but payday loans are not that kind of debt.

Unlike legitimate credit card providers, who will report your payments to the credit bureaus, payday lenders will not generally report your payments. Unless of course, you miss payments. Then your account gets turned over to collections, and collections will definitely report your lack of payment. Even in the best case scenario, these predatory bad credit loans won’t help your credit. And in the worst case scenario, it can mess it up really bad.

Read about how protect yourself from dangerous loan practices in our ebook How to Protect Yourself from Payday Loans and Predatory Lenders.

4. Day in, day out

But surely payday lenders are mainly lending to irresponsible people, right? Not at all! Although it’s nice to imagine that everyone who gets ripped off deserves it, that’s rarely the case (and deciding who “deserves” to get ripped off doesn’t sound like a good idea anyway). A Pew study found that 69% of payday borrowers use their loans to pay for everyday recurring expenses, like rent and utility bills.

Given all the other terrifying stats about payday loans, it’s clear this is not a sustainable way to live one’s life. Unfortunately, the borrowers often have no other choice. (If they have a car, they could look to title loans loans, but those still a pretty bad option. Same goes for high-interest cash advances.) The other 31 percent of payday loan users, who use their loans for one-time unexpected expenses are likely also dealing with necessities, like car repairs or medical expenses. It’s a lot of people with no other options being taken advantage.

5. The 14%

Ready for one last horrible stat? A later Pew study found that only 14% of payday borrowers can afford to repay their loan. That’s not a high percentage. It’s why so many payday loan customers are forced to roll over their loans or reborrow them. Unlike installment loans, which allow borrowers to pay their loan back in a series of smaller, more manageable payments, payday loans make you pay your entire loan back at once.

Given all the other stats we shared above, it paints a grim picture for a lot of people. Hopefully, you can use these stats as motivation to do whatever you can to avoid payday lenders, and find whatever better alternatives you can within your credit space.

Further reading and watching:

Do you have personal experience using payday loans? We want to hear from you! You can email us, or you can shoot us at tweet at @Opploans.

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Know Money, Win Money! Episode Two: Payday Loans

opploans - know money, win money

Hello, money fans! It’s time for the newest episode of Know Money, Win Money!

We quizzed people about payday loans and gave them money when they got it right. Hopefully they didn’t have to spend that money paying off a payday loan, but if they did, then fingers crossed that was the last bit they needed to pay it off!

You can watch the episode below:

The first question we asked was about the average payment term for a payday loan. That is, how long you have to pay back the full loan amount with all fees and interest included. The answer? Only two weeks. Which means a lot of people are forced to…

Rollover their loan. We asked people what that means, and some of them knew! In case you don’t know, it means that you pay to extend the loan, which can be the start of a vicious cycle of debt. You can learn more about Payday Loan Rollover (an its many, many dangers) here in our blog.

Next we told people that payday loans have an average of 400% APR and asked what APR stands for. It’s Annual Percentage Rate, and it’s a number that describes the full cost of a loan including all interest and fees. That lets you compare different loans in an “apples to apples” fashion to figure out which one makes the most sense for your needs.

Finally, we asked how installment loans are different from payday loans. As the name suggests, installment loans allow you to pay off the loan over time, in installments, so you can manage your finances without falling behind.

All right, now that you know about payday loans, don’t go get one! But do get money when you run into us the next time we’re on the street playing Know Money, Win Money!

Be sure to also check out our previous Know Money, Win Money blog and episode about credit.

What are some financial topics that you’d like us to cover in future episodes of Know Money, Win Money? We want to hear from you! You can email us by clicking here or you can find us on Twitter at @OppLoans.

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What’s the Difference Between a Payday Loan and an Installment Loan?

male lion sitting in the safari

If you’re looking to borrow, you may already know about payday loans—they’re fast, dangerous, and designed to take advantage of those in need. (Think of them as the jackal of the lending animal kingdom.) Is there a better option? Something just as fast, but… you know, not evil?
You bet there is.
When it comes to lending, consider the personal installment loan the noble lion, king of the lending jungle.

Payday Loans: Scavenging on your finances.

“Payday loans… can destroy a borrower’s credit and wipe out their bank account.”

Payday loans are short-term, unsecured loans that target the financially vulnerable—the low income, the elderly, and those without limited financial education. Payday lenders won’t perform a credit check and, depending on the restrictions in your state, they may not even check your income first.

Fast money without a credit check? What could be wrong?

Well, a lot. Payday loans charge unfair fees and massive interest rates, meaning they have extraordinarily high annual percentage rates (APRs)—the measurement that allows you to see the full cost of a loan.

Certified financial educator Maggie Germano (@MaggieGermano) says, “Payday loans usually turn out very negatively for the borrower. Interest rates and fees are sky-high and many people are unable to pay them back in time. Every time you miss your payment due date, the amount owed increases significantly. This makes it impossible for people living paycheck to paycheck to pay them off. This can destroy a borrower’s credit and wipe out their bank account.”

It may be tempting to try out the fast, risky option with the short payment terms, but don’t forget: it’s a trap. Read more about payday loans in our eBook How to Protect Yourself from Payday Loans and Predatory Lenders.

Installment Loans: The lion king of lending 

“A good installment [loan]… can actually build up your credit and [help you] qualify for a better loan next time.”

When it comes to payment terms, installment loans are the exact opposite of payday loans. Instead of having to make a massive payment in a short amount of time, installment loans offer you the chance to make regular, smaller payments over a much longer period.

Most installment loans will offer you a MUCH lower APR on your loan than a dangerous payday loan and also—unlike many payday loans—they won’t charge a sneaky prepayment penalty.

What’s a prepayment penalty? Law professor David Reiss (@REFinBlog) sums it up well: “Prepayment penalties come into play if the borrower repays all or part of a loan before the payment schedule that the borrower and lender had agreed upon when the loan was first made. In theory, they compensate the lender for the costs of making the loan in the first place and any decrease in interest payments that the lender would get as a result of early repayment. In practice, prepayment penalties can be a new profit center for lenders if the fees are set higher than the amounts actually lost by prepayment.”

A good installment lender will also report your payments to credit bureaus, so you can actually build up your credit and qualify for a better loan next time.

So which loan is right for you? 

If you know with 110% certainty that you’ll be able to pay off your loan, with all of the interest and fees, as soon as it is due, then a payday loan may be a workable option. But that’s not usually what happens. In fact, according to the Consumer Financial Protection Bureau, four out of five payday loan borrowers find themselves forced to rollover (extending the term of their loan at the cost of another round of fees and interest)1 and the average payday borrowers are in debt to their lender a stunning 200 days of the year.2 So remember, with a payday loan, the odds are never in your favor.

Installment loans are a safer option, especially if you find a lender who is willing to work out terms that fit for you. It’s also important that they have good customer service representatives so you can reach someone in advance if you’re ever worried you might miss a payment. Finally, make sure that there’s no prepayment fee and they report your payments to credit bureaus so you can get an even better loan next time.

The world of lending can certainly feel like a jungle. So always go with a trusted, reliable leader—rather than a dangerous predator running down easy prey.

Visit OppLoans on YouTube | Facebook | Twitter | LinkedIN | Google+

References
1 “CFPB Finds Four Out Of Five Payday Loans Are Rolled Over Or Renewed.” ConsumerFinance.gov March 25, 2014 https://www.consumerfinance.gov/about-us/newsroom/cfpb-finds-four-out-of-five-payday-loans-are-rolled-over-or-renewed/. Accessed 30 March 2017.

2 Morran, Chris. “The Average Payday loan Borrower Spends More Than Half The Year In Debt To Lender.” Consumerist. April 26, 2013. https://consumerist.com/2013/04/26/the-average-payday-loan-borrower-spends-more-than-half-the-year-in-debt-to-lender/. Accessed 23 March 2017.


Contributors

Maggie Germanois a Certified Financial Education Instructor and financial coach for women. Her mission is to give women the support and tools that they need to take control of their money, break the taboo of discussing debt and income, and achieve their goals and dreams. She does this through one-on-one financial coaching, monthly Money Circle gatherings, her weekly Money Monday newsletter, and speaking engagements. To learn more, or to schedule a free discovery call, visit maggiegermano.com.

David Reiss, is a professor at Brooklyn Law School and director of academic programs at the Center for Urban Business Entrepreneurship. He is the editor of REFinBlog.com, which tracks developments in the changing world of residential real estate finance.

What is the Payday Loan Debt Cycle?

Payday loans. You know they’re bad. And if you don’t, we have some information for you: payday loans are bad. Like, dangerous, disastrous, how-are-these-even-legal bad.
From high-interest rates, to short terms, and deceptive practices, there are many reasons why payday loans are best avoided.
But what exactly makes these predatory loans the worst of the worst? A little thing called the payday debt cycle.

What are Payday Loans?

According to Michelle Hutchison (@MichHutchison), a money expert at finder.com (@findercomau), “A payday loan is a short-term, alternative form of credit that can be accessed quickly, even by those with bad credit or no or low incomes. Given the higher risk these loans have for the lender from people who typically have poor credit, and that the loans are unsecured, they generally have higher fees and interest rates than you’ll find for other loan types like personal loans and credit cards.”

And it’s not just the interest and fees you have to watch out for, as Hutchison points out: “They are designed to help people out in a pinch—or between paydays—so the repayment terms are often shorter, ranging from two weeks to a month and occasionally extended to six months.”

Why do people use Payday Loans? 

People tend to seek payday loans when their credit scores are too low to qualify for a traditional loan from a bank or credit union. Additionally, applying for many types of loans can even further damage your credit score. As John Ganotis, founder of Credit Card Insider (@CardInsider) explains: “A credit check from a lender results in something called a hard inquiry. A hard inquiry is a normal part of the lending process and will remain on your credit reports for two years.”

Because payday lenders do not perform a credit check, many potential borrowers with bad credit in need of a loan see payday lenders as their only option to avoid a credit check that could further harm their credit. A better option might be to seek out a lender who performs a “soft credit check,” which will not affect your credit score. But we aren’t talking about what happens with the better option. We’re talking about payday loans.

How do borrowers get trapped by Payday Loans? 

OK, so let’s say you’ve taken out a payday loan (maybe you didn’t know how dangerous they are, or didn’t think you had other options). The interest rate is astronomically high (350 percent) and the terms are really, really short (two weeks). So what happens in the likely event that you aren’t able to pay the money you borrowed (plus all that interest) in time?

You’ll be forced to pay an expensive “rollover” fee to extend the loan. That’s a cost you probably can’t afford, and that’s before you even start to calculate all of the additional interest that will build up from the extension. It’s not hard to see how you might have to roll over the loan again. And again. All while the debt builds up and your credit score goes down. This is it. The dreaded Payday Loan Debt Cycle.

You keep paying. The interest keeps mounting. And all of a sudden, that “two-week loan” is lasting months and months.

As financial writer Jen Smith (@savingwithspunk) told us, “The debt cycle looks different in every family. Sometimes it’s obvious to everyone that debt has been abused but in most cases, debt is gradually racked up and ignored until it builds up to the point that people feel like foreclosure, bankruptcy, or worse are their only options.”

Can you escape the Payday Loan debt cycle? 

According to Jen Smith, “Education is key to escaping the debt cycle. It’s imperative we teach kids and teens about money at appropriate comprehension levels. Many will argue that kids should learn personal finance at home or they won’t listen. Those reasons aren’t good enough for us to leave financial literacy out of schools. Ideally, every grade would have a curriculum with age-appropriate money topics. And more financial literacy content on the internet, where adults spend most of their time, that’s relevant and relatable to people with low incomes is needed to help adults.”

For escaping your own personal debt cycle, you shouldn’t be afraid to ask for help if you know someone in your life who might be able to provide it. Beware of “payday relief” companies, many of which are scams and will just make your situation even worse (read more in our white paper The OppLoans Guide to Safe Personal Loans). One of your better options might be trying to call the loan company directly and see if you can settle for a lesser amount.

You might also consider taking out a personal installment loan with better terms than your payday loan. If your new lender reports on time payments to the credit bureaus, you could actually improve your credit while escaping the payday loan debt cycle.

Bottom line:

It’s not always easy to get out of debt. But budgeting, paying down credit cards, installment loans, and avoiding predatory payday and title loans can help you do it.

Paying off debt and improving your credit will make better options available to you the next time you need money.


Contributors

John Ganotis is the founder of CreditCardInsider.com John comes from a diverse background of software development, web publishing, and personal finance. He knows firsthand what it’s like to accumulate credit card debt, pay it off completely, and then start using credit to his advantage. His passion for technology and attention to detail have made Credit Card Insider one of the premier credit resources on the Internet, and he is eager to help others tackle debt and use credit as a powerful tool rather than fear it.

Michelle Hutchison is finder.com‘s resident Money Expert. Michelle has over seven years’ experience in the financial services and online industries and is a regular commentator on money-related issues. After completing a Bachelor of Arts degree from Australia’s Macquarie University, majoring in Media, Michelle began her career as a journalist in regional radio and TV newsrooms, before working in other media outlets in positions ranging from reporter to editor.

Jen Smith is a personal finance and debt payoff expert. She has been featured on Student Loan Hero, The Penny Hoarder, and AOL Finance. Her website is sSavingWithSpunk.com

Payday Loan Rollover: How Short-Term Loans Turn Into Long-Term Debt

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4 out of 5 payday loan borrowers wind up extending their loans and paying much, much more than they expected to than when they originally borrowed.1 How does this happen? Through a harmless-sounding technique called rollover.


Why Do People “Need” Payday Loans in the First Place?

People who turn to payday loans often have “bad” credit score—a FICO score of 630 or less.

Not sure what a credit score is? Let Katie Ross, Education and Development Manager for American Consumer Credit Counseling explain. “A credit score is all of the data contained in a credit report, which includes credit history and current account statuses, all compiled into one number using the same method for every consumer so it is standardized. The score is a tool for creditors to quickly assess borrowers to make initial product and interest rate offerings without performing a full credit inquiry.”

If you have a low credit score, then you’ve likely had an experience of getting shut out of from borrowing from traditional institutions like banks or credit unions. And it means that the interest rates you pay on the loans you can get are going to be much higher.

Lenders that serve these “subprime” borrowers—people whose credit scores are below average—charge those higher rates in order to protect themselves from risk. Since subprime borrowers default on their loans at a higher rate than borrowers with prime scores, lenders risk losing too much money if they charged them normal interest rates.

Enter: payday loans.

On paper, these are short-term loans with high-interest rates—the perfect way for someone with poor credit to get cash in a hurry. But in the real word, many payday loans end up trapping borrowers in a cycle of extremely high-cost debt, one from which it can take them years to escape. And the reason for that can be summed up in one simple word: rollover.

How does loan rollover work?

When a person cannot afford to pay their payday loan off by the given date, many lenders will give them the opportunity of “rolling over” their loan. It’s basically giving them an extension on the loan’s due date in return for an additional fee.

The most common form of loan rollover involves the borrower paying off only the interest owed on their loan. So for a 14-day, $300 loan with a 15 percent interest rate, rolling the loan over would mean paying the lender the $45 owed in interest in order to secure a 14-day extension on the due date.

But what about that additional fee? Well, what happens is that the lender then charges the borrower an additional 15 percent in interest on this new, extended term. In one fell swoop, the cost of borrowing for this payday loan jumps from 15 percent to 30 percent. That’s a big jump!

And if the borrower is still unable to pay their loan off after the new 14-day term, the lender might have them roll their loan over again.  That’s an additional $45 paid, and an additional 15 percent interest fee charged. The cost of borrowing has now risen to 45 percent, and the borrower is nowhere closer to paying off the original $300 they borrowed.

That’s how a “short-term” payday loan can so easily turn into a long-term problem.

The cost of rollover

If the main appeal of payday loans is that they can get you out of debt fast, then rolling a loan over and over again would seem entirely unappealing. And yet, it’s a fact that many payday loan customers end up with long-term debt.

According to a 2014 study from the Consumer Financial Protection Bureau (CFPB), 80 percent of all payday loans are the result of rollover or reborrowing—which is the practice of taking out a new payday loan soon after the old one is paid back. (Like rollover, reborrowing is a sign that a given borrower cannot afford to pay back their payday loan.) This begs the question: would the payday loan industry survive if its customers could afford to pay back their loans the first time?

Maybe not. Another study from the CFPB cites an alarming statistic: the average payday loan customer takes out 10 loans per year and spends almost 200 days in debt. Even though payday loans are sold as a “short-term” debt solution, these numbers point to a pattern of long-term indebtedness.

The reason that rollover (and reborrowing) are so common for payday loans likely has something to do with how these loans are structured. Specifically, how they are designed to be paid back all at once. According to a study from the Pew Charitable Trusts, the average payday loan borrower states they can afford about $100 a month towards their loan, even though they owe closer to $430.2 With only a few short weeks to pay back the loan, many payday loan borrowers find that they simply cannot afford to pay the loan back all at once.

How to Avoid Payday Loans

Folks with bad credit who are considering a payday loan should instead do two things.

The first thing they should do is consider out taking a long-term installment loan instead—as these loans designed to be paid off in a series of small, manageable payments (read more in What’s the Difference Between a Payday Loan and an Installment Loan?). Instead of accruing an additional interest fee every two weeks without ever touching the loan’s principal amount, borrowers who take out an installment loan would be paying both off principal and interest with every payment they make.

The second thing these people should do is focus on improving their credit scores. The better their credit, the less likely they are to resort to a payday loan.

“It’s no secret that consumers with excellent credit have access to their best credit cards and lowest interest rates,” says Chris Piper, Director of Market Strategy for DriveTime Automotive Group. “Having subprime credit can negatively affect your ability to finance a vehicle, own a home and even got a job – especially if you will have access to money or its’ in the finance industry. Slowly working on improving your credit is imperative to reducing financial stressors in your life.

Piper stresses that, “Outside of regularly reviewing their credit reports and scores (and knowing that you should never pay to review your credit reports or scores), subprime consumers should understand what element of their credit history is keeping their score low.”

He says that “it might be as simple as an incorrectly reported delinquency, or maybe the utilization on a single credit card is too high and negatively impacting their score. Knowing what the exact reasons why their score is low and practicing good credit hygiene and resolving those issues, when possible, is a sure-fire way to move out of the subprime credit range.”

According to Sacha Ferrandi, founder of Source Capital Funding, Inc., “One of the best ways to avoid payday and predatory lenders is to treat credit cards like debit cards, paying back the credit card loan as soon (or shortly after) you make the purchase. This is a great example of borrowing responsibly, as the credit card simply becomes a way to earn points in addition to making a purchase.

If you have credit card debt, make sure to pay off that debt on time” says Ferrandi. “Missed payments will severely hurt your credit score and if your credit score drops low enough, financing from a bank will become next to impossible, leaving only payday advances to rely on if an emergency arises.”

And even if you still need to take out a loan, choosing a personal installment loan could help you pay your bills and improve your credit at the same time. Certain lenders, like OppLoans, report your payment information to the credit bureaus. Payment history a huge factor in how credit scores are calculated.

While there are no “magic bullets” when it comes to raising your score, making your payments on time is a great place to start. Plus, with an installment loan, you’re more likely to have payments you can actually afford. Unlike payday loans, installments loans are designed to be paid off the first time—no rollover required.

Works Cited

1 “CFPB Finds Four Out Of Five Payday Loans Are Rolled Over Or Renewed.” ConsumerFinance.gov. Accessed on February 10, 2017 from https://www.consumerfinance.gov/about-us/newsroom/cfpb-finds-four-out-of-five-payday-loans-are-rolled-over-or-renewed/.

2 “How Borrowers Choose and Repay Payday Loans.” PewTrusts.org. Accessed on February 10, 2017 from http://www.pewtrusts.org/~/media/assets/2013/02/20/pew_choosing_borrowing_payday_feb2013-%281%29.pdf



About the Contributors:

Sacha Ferrandi, is the Founder of Source Capital Funding, Inc. (HardMoneyFirst.com) and is an expert in finance, entrepreneurship, and real estate. Source Capital Funding, Inc., is based in San Diego and operates across the United States.

Chris Piper, Director of Market Strategy for DriveTime Automotive Group (DriveTime.com), the nation’s largest used car dealership network helping people with less-than-perfect credit find and finance a vehicle.

Katie Ross, joined the American Consumer Credit Counseling (ACCC) management team in 2002 and is currently responsible for organizing and implementing high performance development initiatives designed to increase consumer financial awareness. Ms. Ross’s main focus is to conceptualize the creative strategic programming for ACCC’s client base and national base to ensure a maximum level of educational programs that support and cultivate ACCC’s organization.

How (and Why) to Calculate the APR for a Payday Loan

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Sure, you may know that taking out a payday loan is generally a bad idea. You’ve heard a horror story or two about something called “rollover”, but if you’re in a jam, you might find yourself considering swinging by the local brick-and-mortar payday loan store or looking for an online payday loan. It’s just a one-time thing, you tell yourself.

It only gets worse from there… Once you start looking at the paperwork or speaking with the sales staff, you see that your payday loan will cost only $15 for every $100 that you borrow. That doesn’t sound that bad. But what’s this other number? This “APR” of 400%? The payday lender tells you not to worry about it. He says, “APR doesn’t matter.”

Well, let’s just interrupt this hypothetical to tell you this… When you’re borrowing money, the APR doesn’t just “matter”, it’s the single most important number you need to know.

APR stands for “annual percentage rate,” and it’s a way to measure how much a loan, credit card, or line of credit is going to cost you. APR is measured on a yearly basis and it is expressed as a percentage of the amount loaned. “By law, APR must include all fees charged by the lender to originate the loan,” says Casey Fleming (@TheLoanGuide), author of The Loan Guide: How to Get the Best Possible Mortgage.

But just because a loan or credit card includes a certain fee or charge, you shouldn’t assume that it’s always going to be included in the APR. Fleming points out that some fees, like title fees on a mortgage, are not considered part of the loan origination process and thus not included in APR calculations.

“Are DMV fees connected with a title loan? Some would say yes, but the law doesn’t specify that they must be included,” says Fleming.

According to David Reiss (@REFinBlog), a professor of law at Brooklyn Law School, “the APR adds in those additional costs and then spreads them out over the term of the loan. As a result, the APR is almost always higher than the interest rate—if it is not, that is a yellow flag that something is amiss with the APR.”

This is why it’s always a good idea to read your loan agreement and ask lots of questions when applying for a loan—any loan.

APR can sometimes be a tricky measure

If you’re talking about long-term financial products like mortgages or credit cards, APR can get complicated in a hurry.

With mortgages, there can be a ton of fees involved—some of which might very well be excluded from the APR. And with credit cards, your interest usually ends up compounding on a daily basis, which means that you’ll end up paying more than the stated APR.

What does “compounding interest” mean? Well, it means that your interest charges get added to your principal loan amount, which means that you start getting charged interest on your interest. Fun, right?

One more way that APR can be misleading has to do with amortizing installment loans. With these loans, which are paid off in a series of equal, regular payments, a certain portion of each payment always goes towards your principal loan amount. As the principal goes down, the amount of money that is accrued in interest goes down too.

The APR is a measurement of the cost of a loan over its lifetime, calculated from the snapshot of the origination date.” Says Fleming. “If you were to calculate the APR over the balance of a loan midway through its term the number would be different because the advance fees and interest have already been paid. “

Payday Loan APRs are simple (and simply unacceptable)

Compounding interest isn’t something you’ll have to worry about with a payday loan. The principal stays the principal and the interest stays the interest.

And payday loans don’t amortize either. The interest you pay on a payday loan is usually referred to as a “finance charge” and it is a simple fee based on the amount you borrow. For instance, a $300 payday loan that costs $20 per $100 borrowed would have a finance charge of $60.

When considering a loan, you’ll definitely want to make sure it doesn’t include any hidden or additional fees (read more in the eBook How to Protect Yourself from Payday Loans and Predatory Lenders). Other than that, calculating the APR should be a good way to calculate just how expensive that loan is compared to your other options.

In fact, you’ll probably be pretty surprised.

How to Calculate APR for Payday Loans

When calculating the APR for a payday loan, you are going to need three pieces of information.

  1. The principal loan amount, or how much money you are borrowing
  2. The amount you’re paying in interest on the loan, also referred to as the “finance charge.”
  3. The length of the repayment term, or how long the loan will be outstanding.

Got that? Okay.

To make things a bit easier to understand, let’s use an example:

Payday Loan #1 has…

  1. A principal loan amount of $400
  2. An interest amount/finance charge of $80 (a rate of $20 per $100 borrowed)
  3. A repayment term of 14 days.

First, you’ll want to divide the interest/finance charge by the loan principal:

$80 / $400 = 0.2

This tells you how much you are paying relative to how much you are borrowing. 0.2 translates to a rate 20%, which means that you are paying a 20 cents on every dollar that you borrow.

Next, you’ll want to multiply that result by 365, for the number of days in a year:

0.2 x 365 = 73

Next, you’ll want to divide that result by the length of the repayment term:

73 / 14 days = 5.214285

That final result basically states that, if your payday loan were to be outstanding for a full year, you would pay over 5 times the amount you originally borrowed in fees and/or interest. To convert into APR, just move the decimal point two spaces to the right and add a percentage sign:

521.43% APR

(Thanks to ConsumerFed.org for this formula.)

Why is the APR for payday loans so high?

According to David Reiss, “The APR takes into account the payment schedule for each loan, so it will account for differences in amortization and the length of the repayment term among different loan products.”

Keep in mind, that the average term length for a payday loan is only 14 days. So when you’re using APR to measure the cost of a payday loan, you are essentially taking the cost of the loan for that two-week period, and you’re assuming that that cost would be applied again every two weeks.

There are a little over 26 two-week periods in a year, so the APR for a 14-day payday loan is basically the finance charges times 26. That’s why payday loans have such a high APR!

But if the average payday loan is only 14 days long, then why would someone want to use APR to measure it’s cost? Wouldn’t it be more accurate to use the stated interest rate? After all, no one who takes out a payday loan plans to have it outstanding over a full year…

Short-term loans with long-term consequences

But here’s the thing about payday loans: many people who use them end up trapped in a long-term cycle of debt. When it comes time for the loan to be repaid, the borrower discovers that they cannot afford to pay it off without negatively affecting the rest of their finances.

Given the choice to pay their loan off on time or fall beyond on their other expenses (for instance: rent, utilities, car payments, groceries), many people choose to roll their loan over or immediately take out a new loan to cover paying off the old one. When people do this, they are effectively increasing their cost of borrowing.

Remember when we said that payday loans don’t amortize? Well, that actually makes the loans costlier. Every time the loan is rolled over or reborrowed, interest is charged at the exact same rate as before. A new payment term means a new finance charge, which means more money spent to borrow the same amount of money.

“As the principal is paid down the cost of the interest declines,” says Casey Fleming. “If you are not making principal payments then your lifetime interest costs will be higher.”

According to the Consumer Financial Protection Bureau (CFPB), a whopping 80% of payday loans are the result of rollover or re-borrowing and the average payday loan customer takes out 10 payday loans a year.

Reiss says that “the best way to use APR is make an apples-to-apples comparison between two or more loans. If different loans have different fee structures, such as variations in upfront fees and interest rates, the APRs allow the borrower to compare the total cost of credit for each product.

So the next time you’re considering a payday loan, make sure you calculate its APR. When it comes to predatory payday lending, it’s important to crunch the numbers—before they crunch you!



About the Contributors:

Casey Fleming, began as an appraiser in 1979 and built one of the largest appraisal and consulting firms in the San Francisco Bay Area.  He sold the firm in 1995 to transition to mortgage lending. Casey built a team of 300 loan agents from 2003 through 2008, mentoring dozens of senior agents and producing training meetings for hundreds. After the Financial Crisis Casey wrote The Loan Guide: How to Get the Best Possible Mortgage.  to help consumers protect themselves from predatory practices. Today Casey is passionate about educating consumers.

David Reiss, is a professor at Brooklyn Law School and director of academic programs at the Center for Urban Business Entrepreneurship. He is the editor of REFinBlog.com, which tracks developments in the changing world of residential real estate finance.

 

What’s Up with Payday Loans in Kansas City?

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How Many Payday Lenders in Kansas City, MO Have Been Ordered to Pay Settlements in the Past Two Years?

You give up? Four. The answer is four.

That’s right. In the past two years, four payday lenders lenders in the Kansas City-area have paid—or at least been ordered to pay—financial settlements to the US government as a result of unethical business practices.

So What Gives?

Turns out, Kansas City, MO is something of a hub for payday lenders. In Fact, Kansas City alt weekly The Pitch has called Kansas City, “the payday-lending capital of North America.[1] These are businesses that offer short-term, high-interest loans to people who need cash and don’t have (or don’t believe they have) better options available to them.

In each of these cases, it was determined that these payday lenders were taking advantage of customers—usually through misleading terms, confusing loan agreements, and interest rates as high as 700%.

One of these lenders, so-called “payday loan mogul” and, umm, professional racecar driver, Scott Tucker, was just handed a $1.266 billion judgement in federal court. That’s the largest settlement in Federal Trade Commission (FTC) History.

Another lender, Walter Mosely Sr., whose case had not yet been decided, was arrested on the same day as Tucker on similar charges.[2] Mosely’s lending group, by the way, was called Hydra Lenders which … come on, that isn’t even subtle. If you’re going to start a predatory lending business, maybe picking the same name as the very famous bad guys from Captain America isn’t a great idea.

Then there are Tim Coppinger and Ted Rowland, two payday lenders who also settled with the FTC over charges of deceptive and unethical lending. Coppinger was ordered to pay $32 million and Rowland was ordered to pay $22 million.[3]

So what’s being done about it?

If you want to know what's going on with payday lending in America, check out what's happening in Kansas City, Mo.

Since Kansas City is an industry hub for payday lending, it's clearly drawing a lot of attention. For instance, it is no coincidence that the Consumer Financial Protection Bureau chose Kansas City of all places to announce their new rules to crack down on predatory payday lending. If you want to know what's going on with payday lending in America, check out what's happening in Kansas City, Mo.

And what is happening with payday loans in Kansas City right now is exactly what should be happening. The federal government is stepping in, investigating reports of abuse and issuing heavy fines to lenders who have engaged in unethical behavior. Did you know that the $1.266 billion dollar settlement against Scott Tucker the largest settlement in the FTC's history? Sounds like they’re taking this seriously.

At OppLoans, we believe in being socially responsible, and in issuing loans that our customers can afford to repay. People with less-than-perfect credit deserve better than payday loans in Kansas City, and everywhere else. So for the sake of borrowers in Kansas City, and around the country, we hope to see lots more stories like these ones in the months and years to come.

References:

  1. Vockrodt, S. “KC’s dethroned online payday lenders aren’t gaming the feds anymore.” Retrieved October 12, 2016 from http://www.pitch.com/news/feature-story/article/20553808/payday-lending-kansas-city-joel-tucker

  2. McGuire, D., Rosen, S. Campbell, M. “KCC payday lenders Scot Tucket and Richard Moseley Sr. indicted in federal crackdown.” Retrieved October 10, 2016 from http://www.kansascity.com/news/business/article59551056.html

  3. Hudnall, D. “Unpacking the FTC's payday-lending settlement with Tim Coppinger and Ted Rowland.” Retrieved October 12, 2016 from http://www.pitch.com/news/article/20562219/unpacking-the-ftcs-paydaylending-settlement-with-tim-coppinger-and-ted-rowland

Finance Fridays: Another Rough Week for Payday Loans

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Payday loans continued to make headlines for all the wrong reasons this week. Between more cities and states enacting tougher regulations against payday loans, criminal banking practices coming to light, and socially responsible lending innovators winning major awards (what?) this was a busy week. At OppLoans, we track these stories closely because nothing is more important to us than helping borrowers avoid these predatory lenders and their bad products. So, for payday loan and personal finance newshounds like us, this was another big week of headlines.

Check out all the lending, saving, and budgeting stories that hit our radar this week. We’ve put one favorite at the top (shout out to socially responsible lending!) followed by more helpful money tips and articles for you to enjoy. Happy (Finance) Friday!

Here are our top 10 personal finance stories from this week:

MacArthur Foundation: the 2016 “Genius Grants” were just announced and one of them caught our eye. José A. Quiñonez founded the Mission Asset Fund in San Francisco to facilitate lending circles in unbanked communities, helping folks establish a credit history from scratch. That’s … oh, what’s the word … genius!

New York Times: Massachusetts Senator Elizabeth Warren is not happy with Wells Fargo.

Cosmopolitan: Weddings are very expensive, so here’s 19 ways to save money while still celebrating your special day.

St. Louis Post-Dispatch: The Springfield, MO city council just passed a resolution supporting the Consumer Financial Protection Bureau’s (CFPB’s) proposed rules for payday lenders.

Telegraph-Forum: This article examines the effects of the CFPB’s proposed rules on payday lenders in Ohio.

Credit.com: How does having student loan debt affect your ability to get a home mortgage?

NerdWallet: Have bad credit? Let a financial expert explain how you can recover.

Forbes: Retirement is going to arrive sooner than you think. Here’s three ways you can save money to support you in your golden years.

Yahoo! News: The Holidays are coming. Do you have money for gifts? If the answer is no, check out some ways you can save money this fall.

Huffington Post: Entrepreneurs are famous for being thrifty, but here are some methods to make sure that you are cutting your costs effectively.

ICYMI this week on the OppLoans Blog:

OppLoans Word of the Week: Cash Advance

LendingTree Names OppLoans #1 Customer-Rated Personal Lender

Cut the Cord: Save Money with Cable TV Alternatives

Longer Terms or Lower Payments: Which Debt Consolidation Strategy is Right for You?

Have a great weekend everybody!

When you need cash in a hurry, it can be tempting to turn to a predatory payday or title lender. Don’t do it. Apply for a safe, reliable personal installment loan from OppLoans instead. We have longer terms, lower rates, and better customer service. To learn more, or to apply for a loan today, check out our homepage: OppLoans.com.