Payday Loans: Confusing by Design
Inside Subprime: Dec 7, 2018
By Oriana Schwindt
Payday loans are confusing by design. Predatory payday lenders want borrowers to understand as little as possible about the associated charges when a loan is issued. While all payday loans are required to clearly state the interest rates and fees they charge, these companies can find ways to obfuscate, including tactics as simple as hiding information in the fine print.
Sometimes, payday loan firms use unscrupulous methods of trapping borrowers in debt that are caught by regulators. Take the example of Joel and Scott Tucker, who created a payday loan empire out of Kansas City, Missouri. Scott Tucker was sentenced to 16 years and eight months in prison in January 2018 after being convicted of racketeering and running an illegal payday loan operation. His brother, Joel, was convicted in July after creating and selling fake debts for 7.7 million people.
Many more Americans incur harm from payday loans without receiving restitution. Some states do little to regulate the industry, and even in states with significant protections, lenders find loopholes that allow them to charge exorbitant rates and fees. And as the Consumer Financial Protection Bureau has moved towards reduced oversight of payday loan providers, the responsibility is left to consumers to understand and avoid payday loans. Armed with some basic knowledge, consumers can avoid getting trapped in an ongoing cycle of debt.
Understanding Interest Rates
Before taking out a payday loan, it’s important that a borrower understands the total cost. Payday loan providers are required by the Truth in Lending Act to tell you the real annual interest rate (APR) you’ll be paying when you take out a payday loan. But plenty of borrowers are still caught off guard when they realize the interest rate they’re paying is much higher than they initially thought.
Even in states that put limits on interest rates by law, the total cost is not always transparent. Added fees can push the effective annual percentage rate into the triple digits.
For example, a fee of $75 on a $375 loan is equal to an APR of 521 percent. This is calculated by dividing the charge by the principal of the loan and multiplying that number by 365. The answer is divided by the number of days in the loan term, and then multiplied by 100 to get a percentage rate.
The calculation looks like this:
$75 ÷ $375 = .2
.2 x 365 = 73
73 ÷ 14 = 5.21
5.21 x 100 = 521%
Understanding Loan Principal Versus Total Cost
In addition to paying back the original amount of a loan, borrowers need to pay back any associated interest and fees within the allotted time period. But payment options are frequently framed in ways that are difficult to understand. Often, a borrower needs to decline the option to rollover a loan, which requires the borrower to pay back the loan proactively.
What happens if you don’t pay off the entire loan on the day it’s due? Depending on laws within your state, the lender may automatically roll your loan over. Though not allowed in all state, this automatic process is one reason some 80 percent of payday loan borrowers have their loans rolled over or renewed.
If you take out a $300 payday loan with a $90 fee, you might think you will be finished paying off the loan once $390 has been withdrawn from your account. But if it takes longer than the loan term to pay off the loan, you’ll also be paying additional interest payments.
Online payday lenders, in particular, can obscure this information by linking to lengthy documents that most borrowers decline to read, even though they must indicate that they’ve read the documents before proceeding.
Some borrowers only discover this chicanery when they realize their bank account is overdrawn, or they go to pay a bill and realize they don’t have enough money to do so.
Payday loan providers love legal technicalities, and this is one of them. If you don’t pay the full balance of your loan when it is first due—including interest and the entire principal amount—most of these lenders will automatically roll over your loan, charging you a new finance fee, and resetting the two-week clock. They will push you into a debt hole and hand you a shovel.
Understanding Online Payday Loans
Even in states where payday lending is banned, you still may be able to take out a payday loan online.
Some states may not explicitly prohibit payday lending, but the imposed interest rate caps make it unattractive for payday lenders to set up shop, effectively eliminating storefront businesses in the state. Other states may authorize only certain kinds of businesses to make payday loans.
In order to circumvent state regulations, some unscrupulous payday loan companies will pay Native American tribes to use their names to set up their operations, because the tribes aren’t subject to state regulations on these loans. However, in several cases where a payday lender has paid a tribe for this purpose, the payday lender profits enormously while giving the tribe as little as one percent of the earnings. Scott Tucker paid a tribe $120,000 to use their name for his payday loan operation and profited to the tune of $2 billion.
Understanding Consumer Protections
The Consumer Financial Protection Bureau was created in 2009 by the Dodd-Frank Act with the explicit purpose of protecting consumers from predatory lenders. After unscrupulous mortgage lenders helped lead the American economy into a crisis, the CFPB was supposed to prevent that from happening again. But the CFPB, under the previous presidential administration, also took a keen interest in cracking down on predatory payday lending.
However, Trump-appointed acting director Mick Mulvaney has almost completely rolled back existing protections, and said at the beginning of 2018 he would be reviewing all of the agency’s policies. This includes a review of the 2017 payday lending rule, which has yet to go into effect. The rule would cap interest rates on longer-term loans to 36 percent and force lenders to be more rigorous in determining a borrower’s ability to repay, but the CFPB is expected to repeal at least some of these limits.
Though the CFPB is no longer a reliable ally in the fight against predatory payday lending, all state governments have a department that deals with consumer finance or credit. If you believe you’ve been a victim of predatory lending practices, find out which department in your state government handles complaints about payday lenders and get in touch with them. The National Consumer Law Center, an organization that advocates for consumer rights, is another good resource.
Avoiding Payday Loans
Another way to ensure you don’t become a victim is to avoid taking out a payday loan in the first place. While every person’s financial situation is different, there are always safer alternatives.
If you’re struggling to make ends meet, consider seeking assistance from government programs or nonprofit organizations. Before taking out a payday loan to cover food or medical costs, visit a food pantry or sliding-scale medical clinic in your area. There are also local community organizations that offer financial support for utility bills and rent.
If you can’t avoid borrowing, it’s worth talking to banks and credit unions about their loan products, or applying for a credit card. You may also consider taking out an installment loan, which carries lower interest rates and will help you build credit. Once you’re out of debt, you can begin formulating a savings plan or secure additional income to avoid borrowing money in the future.