A $1,000 Loan Can Balloon Into A $40,000 Debt--And It's Legal
A few years back, payday loan customer Naya Burks of St. Louis borrowed $1,000 from AmeriCash Loans. Like four out of five borrowers of these high-cost loans, she was unable to pay it back in time. When she eventually defaulted on her loan, AmeriCash sued her. Even after she agreed to an installment plan to pay it back, the loan continued to grow at 240 percent interest.When investigative journalists at ProPublica approached AmeriCash about the case, they quietly settled it, but if they hadn’t, Burks would have owed more than $40,000 on that original $1,000 loan. At that point, her only choice would have been to declare bankruptcy.
The idea that a $1,000 loan could balloon to $40,000 or more sounds ludicrous, but it’s often legal. In many states, payday and auto title lenders charge triple-digit interest rates on loans that often leave borrowers worse off than before. These are just among the many ways in which lenders set borrowers up for failure.
The Center for Responsible Lending (CRL) recently released a report detailing how alternative lenders trap people in costly revolving debt that leads to a laundry list of mounting problems . According to CRL, borrowers frequently stack multiple predatory loans atop one another in a futile attempt to dig out from under the initial costly loan. These loans ruin their credit, which further impedes access to affordable loans and can even disqualify borrowers from many jobs. Borrowers can also forfeit important assets such as the family car as the penalty for defaulting on a minor loan, which can further impede employment. And high cost loans can pull family members and friends into a vortex of predatory debt. It all often culminates in a costly bankruptcy proceeding.
In addition to harming borrowers, these alternative lenders also represent a net drain on the economy. According to the CRL report, in 2012, payday lending cost the economy almost $1 billion and more than 14,000 jobs. Ultimately, we all pay the price for these predatory products.
If this is the story of borrower failure, a new paper by the Center for American Progress (CAP) proposes looking at consumer credit products through the lens of borrower success. (Disclosure: I am a Senior Fellow at CAP, but was not involved in the preparation of this study.)
As CAP and CRL both point out, the tricks and traps that borrowers encounter at many financial services storefronts are not random, but rather are an essential aspect of their business models. CAP believes that the extension of financial services should result in a mutually beneficial transaction for borrower and lender. And lending for success requires no magic formula. It simply means ensuring that, as common sense would suggest, the incentives for both lenders and borrowers line up all the way through the life of a loan. It means making sure the borrower can actually pay back the whole loan without needing another loan to do so. It means that the loan is predictable, without exploding interest rates, excessive fees, or payments that don’t pay down the balance. And it means that when borrowers do fall behind, lenders work with them first instead of taking their home or car right away.
Over the past few years, Congress has eliminated some of the most abusive practices in the financial services industry. The Credit Card Accountability, Responsibility And Disclosure Act of 2009 has saved consumers $12.6 billion annually on abusive credit card practices, seeking to purge from the marketplace predatory cards that charged as much as $178 in fees on a $250 line of credit all the while expecting the borrower to exceed the remaining credit limit and be hit with another fee. A year later, the Dodd-Frank Wall Street Reform and Consumer Protection Act established the Consumer Financial Protection Bureau, or CFPB, which is estimated to have provided over 15 million consumers $4.6 billion in relief from illegal financial practices.
Both of those laws are important, but far too many financial predators continue to operate on the margins of regulatory oversight. Most payday and auto title lenders, for example, remain weakly regulated at the state level. The federal Consumer Financial Protection Bureau is developing new regulations to address the problem, and consumer protections in this market can’t come soon enough.
Fortunately, some banks and credit unions have been very proactive in developing and promoting products intended to compete with high-cost loans that lead borrowers to failure. But it’s not a level competitive playing field when risky lending practices and short-term profits rule the day—as they did before the financial crisis—rather than approaches that work for both banks and borrowers.
For America’s families to be economically secure, we must ensure that everyone can access affordable and sustainable mainstream credit. We still have a long way to go to reach this destination, but policymakers can forge a path forward by ending costly debt traps and supporting lending for success.
Jim Carr is Senior Fellow for the Center for American Progress and Co-editor of the book, Replicating Microfinance in the United States. He is also the incoming Coleman A. Young Endowed Chair and Professor of Urban Affairs at Wayne State University.