[Senate Hearing 113-456]
[From the U.S. Government Publishing Office]
S. Hrg. 113-456
ARE ALTERNATIVE FINANCIAL PRODUCTS SERVING CONSUMERS?
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HEARING
before the
SUBCOMMITTEE ON
FINANCIAL INSTITUTIONS AND CONSUMER PROTECTION
of the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED THIRTEENTH CONGRESS
SECOND SESSION
ON
EXAMINING THE SMALL-DOLLAR CREDIT MARKET TO BETTER UNDERSTAND THE
SPECTRUM OFALTERNATIVE FINANCIAL PRODUCTS, CONSIDER POTENTIAL CONSUMER
LENDING CONCERNS, AND REVIEW THE CURRENT FEDERAL AND STATE REGULATORY
LANDSCAPE
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MARCH 26, 2014
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Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
Available at: http: //www.fdsys.gov /
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
TIM JOHNSON, South Dakota, Chairman
JACK REED, Rhode Island MIKE CRAPO, Idaho
CHARLES E. SCHUMER, New York RICHARD C. SHELBY, Alabama
ROBERT MENENDEZ, New Jersey BOB CORKER, Tennessee
SHERROD BROWN, Ohio DAVID VITTER, Louisiana
JON TESTER, Montana MIKE JOHANNS, Nebraska
MARK R. WARNER, Virginia PATRICK J. TOOMEY, Pennsylvania
JEFF MERKLEY, Oregon MARK KIRK, Illinois
KAY HAGAN, North Carolina JERRY MORAN, Kansas
JOE MANCHIN III, West Virginia TOM COBURN, Oklahoma
ELIZABETH WARREN, Massachusetts DEAN HELLER, Nevada
HEIDI HEITKAMP, North Dakota
Charles Yi, Staff Director
Gregg Richard, Republican Staff Director
Dawn Ratliff, Chief Clerk
Taylor Reed, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
______
Subcommittee on Financial Institutions and Consumer Protection
SHERROD BROWN, Ohio, Chairman
PATRICK J. TOOMEY, Pennsylvania, Ranking Republican Member
JACK REED, Rhode Island RICHARD C. SHELBY, Alabama
CHARLES E. SCHUMER, New York DAVID VITTER, Louisiana
ROBERT MENENDEZ, New Jersey MIKE JOHANNS, Nebraska
JON TESTER, Montana JERRY MORAN, Kansas
JEFF MERKLEY, Oregon DEAN HELLER, Nevada
KAY HAGAN, North Carolina BOB CORKER, Tennessee
ELIZABETH WARREN, Massachusetts
Graham Steele, Subcommittee Staff Director
Tonnie Wybensinger, Republican Subcommittee Staff Director
(ii)
C O N T E N T S
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WEDNESDAY, MARCH 26, 2014
Page
Opening statement of Chairman Brown.............................. 1
Opening statements, comments, or prepared statements of:
Senator Toomey............................................... 2
WITNESSES
G. Michael Flores, Chief Executive Officer, Bretton Woods, Inc... 4
Prepared statement........................................... 27
Responses to written questions of:
Senator Brown............................................ 82
Senator Toomey........................................... 84
Senator Moran............................................ 87
Stephanie Klein, Director, NetCredit Consumer Lending, Enova
International.................................................. 6
Prepared statement........................................... 28
Nick Bourke, Director, Safe Small-Dollar Loans Research Project,
The Pew Charitable Trusts...................................... 7
Prepared statement........................................... 29
Responses to written questions of:
Senator Brown............................................ 89
Senator Toomey........................................... 97
Senator Vitter........................................... 104
David Rothstein, Director, Resource Development and Public
Affairs, Neighborhood Housing Services of Greater Cleveland.... 9
Prepared statement........................................... 43
Nathalie Martin, Frederick M. Hart Chair in Consumer and Clinical
Law, University of New Mexico School of Law.................... 11
Prepared statement........................................... 47
Responses to written questions of:
Senator Brown............................................ 109
Senator Toomey........................................... 120
Additional Material Supplied for the Record
Letter from Thomas J. Curry, Comptroller of the Currency,
submitted by Chairman Brown.................................... 123
Letter from John W. Ryan, President and CEO, Conference of State
Bank Supervisors............................................... 125
Statement submitted by The American Financial Services
Association.................................................... 127
Email submitted by Senator Vitter................................ 166
(iii)
ARE ALTERNATIVE FINANCIAL PRODUCTS SERVING CONSUMERS?
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WEDNESDAY, MARCH 26, 2014
U.S. Senate,
Subcommittee on Financial Institutions and Consumer
Protection,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Subcommittee met at 10:03 a.m., in room SD-538, Dirksen
Senate Office Building, Hon. Sherrod Brown, Chairman of the
Subcommittee, presiding.
OPENING STATEMENT OF CHAIRMAN BROWN
Chairman Brown. The Subcommittee will come to order.
Thank you all for joining us. I thank the witnesses for
being here and arriving on time. Senator Toomey, thank you for
your cooperation, and Senators Heller and Warren and Senator
Vitter was here a moment earlier, I believe is returning.
I want you to imagine that--we apparently are going to be
called out to votes around 11, and there are four votes, so we
will go as long as we can and likely dismiss, because there are
four votes. If that means all of us, including Pat and I should
keep our remarks within 5 minutes and ask all of you to do the
same.
Imagine you are 40 years old. Imagine you are living in Mr.
Rothstein's home State of Ohio. You are working at a steel mill
in a union job. You are earning $60,000 a year. The plant shuts
down. It could not compete. It might have been Oil Country
Tubular Steel. It could not compete with illegal dumped imports
from China.
You manage to find a retail job working full-time making
$22,000 or $23,000 a year. Your income is a fraction of what it
used to be. Your costs are about the same, and some things--
perhaps food, gas, health care--are going up. You may lose your
home to foreclosure. You are just trying to make ends meet,
hoping you can just buy enough time until your next paycheck,
with the perhaps distant hope of a better-paying job.
You applied for several credit cards. You were denied. You
decide to take out a payday loan or loan against the title of
your car, but the money from your loan runs out before the next
pay period. Like 80 percent of consumers in the CFPB's recent
study, you end up rolling over your loan. You end up, like the
average borrower, rolling your loan over six or seven times,
eventually paying $575 in fees that you cannot afford on a $400
loan. People are forced to turn to loans too often with triple-
digit interest rates that trap them in a cycle of debt that
leaves them worse off than when they began.
The Office of the Comptroller of the Currency said in 2003,
about a different subject but similar in some ways, quote, ``a
fundamental characteristic of predatory lending is the
aggressive marketing of credit to prospective borrowers who
simply cannot afford the credit on the terms being offered.''
The OCC was talking about mortgages in 2003.
The results of predatory lending devastated millions of
American families, far too many certainly in the States
represented here, especially, I think, especially Nevada and
Massachusetts--or Nevada and Pennsylvania and Ohio. During the
financial crisis, one mortgage lender said, ``If you have a
pulse, we give you a loan. If you fog the mirror, we give you a
loan.''
I am concerned we are now seeing this definition of
predatory lending at work in small-dollar loan markets. For
years, payday loans and other short-term small-dollar credit
products were marketed to consumers and policy makers as a one-
time stopgap to get people through a temporary emergency. Now,
we are seeing these products are being used to cover basic
living expenses that lenders rely on repeat lending for their
profitability. Obviously, a renewal, a rollover loan, is more
profitable than the initial loan, which may not be that
profitable to the lender.
The cycle of a debt is a result of workers' wages
stagnating over the past decade, American families' inability
to accumulate enough wealth through savings over a lifetime
spent working. Senator Toomey and I did a hearing on that, the
bottom half of the population not being able to even close to
saving any significant money for retirement. And the cycle of
debt is a result of weak consumer protection, leaving consumers
vulnerable to financial predators.
This is a large problem. Twelve million Americans use
payday loans for years. Small-dollar lending is an $80 billion
per year business. There are more payday lending stores in the
United States today than there are Starbucks and McDonalds
combined.
This problem is not simple. In my view, we need to raise
the minimum wage. We need to extend unemployment insurance. We
need to expand the Earned Income Tax Credit. All three of those
rewarding work, so that people work hard, they get something
and have some kind of decent standard of living. It puts money
in people's pockets. It grows the economy.
We need to do more to encourage savings and wealth
building. Senator Moran from Kansas and I have introduced
legislation to promote prize-linked savings accounts to help
consumers build assets. And we need a strong CFPB and robust
consumer protections to ensure these products are affordable
and sustainable. It means limits on cost requirements that
consumers can repay their loan, products with longer repayment
terms, and the ability to pay down principal. People who are
working--and most of the people in these situations are--should
have a little bit more to say for what they have--for the work
they have done.
Senator Toomey.
STATEMENT OF SENATOR PATRICK J. TOOMEY
Senator Toomey. Thank you, Mr. Chairman.
You know, I find this discussion always is a very
interesting one to me. I think there is a broad acknowledgement
that we have a huge segment of Americans who are what is
sometimes described as underbanked. They do not have access to
ordinary forms of credit, ordinary meaning that which typically
higher-income, wealthier Americans have access to. And there is
a vibrant, competitive market that meets the needs that they
have, providing short-term credit in a variety of forms, under
a variety of circumstances.
And yet we have got people in this town who want to shut
off this access to credit in a number of ways, use regulators
to shut down the lending industry, directly or indirectly,
sometimes by forbidding banks from providing basic services to
these lenders. We have got some people who think the Government
should take over the business. Let us have the Government do
it, because the Government is so good at everything else it
does. We have got others who think that the Government should
dictate prices. That is what the Government is here for, it is
to set prices for goods and services, and in this case, it
would be the price of credit in the form of a cap on interest
rates.
There are lots of ideas that we hear, and the one idea that
very seldom gets discussed is what about personal freedom? What
about allowing free men and women to decide what works for
them? I have got to say, there is a breathtaking underlying
arrogance in the presumption by wealthy people who have never
been in these circumstances that they know better than those
people who make these foolish decisions and borrow this money
from these institutions, an arrogance that suggests that, God
forbid, we let people decide what is the most sensible thing
for them to do in the circumstances that they face.
And that is the fundamental premise here, that people must
not be free to decide what credit vehicle is most suitable for
them among the options that are available to them. We cannot
let people decide for themselves. We must preclude a whole
range of choices and force them into transactions that we
sitting up here approve of.
I just find that very, very disturbing. I know that view is
not shared by everyone on this Committee. But, I appreciate the
opportunity to have the discussion because I think we ought to
hear from a wide range of opinions about this, and as for
myself, Mr. Chairman, I hope that we will allow for a flexible
and vibrant and dynamic marketplace that will allow people to
access credit that they need in a variety of ways.
Thank you.
Chairman Brown. Thank you, Senator Toomey.
Senator Warren.
Senator Warren. I would like us to just get straight to the
questions, so I will pass. Thank you.
Chairman Brown. Senator Heller, would you like an opening
statement?
Senator Heller. No, Mr. Chairman.
Chairman Brown. OK. Thank you for that. Let me introduce
the panel and get started. I appreciate Senator Heller and
Senator Warren's comments, or lack of comments.
[Laughter.]
Chairman Brown. Michael Flores is President and CEO of
Bretton Woods, Inc. He has over 30 years of experience in the
financial industry. He has testified to this Subcommittee
before.
Stephanie Klein of Enova is the Director of Consumer
Lending for them, an online financial services company
headquartered in Chicago. She oversees NetCredit line of
Enova's installment loan products. Welcome.
Nick Bourke is with Pew Charitable Trusts. He is the
Director of the Pew Charitable Trusts Safe Small-Dollar Loans
Research Project, conducting research on consumer needs and
perceptions, market practices, and potential regulations of
payday and other small-dollar loan providers. Welcome, Mr.
Bourke.
David Rothstein is familiar to this Subcommittee, also. He
is the Director of Research Development and Public Affairs for
the Neighborhood Housing Services of Greater Cleveland. He has
published dozens of research reports, editorials, pieces of
testimony on asset, housing, and consumer issues and has added
greatly to the public debate on these issues.
Professor Nathalie Martin is the Frederick Hart Chair in
Consumer and Clinical Law at the University of New Mexico
School of Law. Her primary research focus is on small-dollar
lending and public attitudes toward these products. Professor
Martin, welcome.
Mr. Flores, if you would begin. Thank you.
STATEMENT OF G. MICHAEL FLORES, CHIEF EXECUTIVE OFFICER,
BRETTON WOODS, INC.
Mr. Flores. Thank you, Chairman Brown, Ranking Member
Toomey, and Members of the Subcommittee. I am grateful for the
opportunity to speak with you today on the issues of consumer
credit and also discuss the results of a report I recently
completed on the customer and loan characteristics of online
short-term loans.
I worked in banking consulting for well over 30 years, and
in the past 15 years, I have conducted research on short-term
credit, including overdrafts and payday loans, and in the last
6 or 7 years, I have studied prepaid cards, as well. I am also
on the faculty of the Pacific Coast Banking School of the
University of Washington, where I teach a retail banking
course.
Based on my most recent research, which was commissioned by
the Online Lenders Alliance, and analysis of other studies, the
need for short-term low-dollar products is real and the demand
is growing. I just noticed an article in the Washington Post. A
Brookings Institution study says that now one-third of all
households are living paycheck to paycheck, so the income is
creeping up higher into the middle class for the need for
short-term credit.
The Center for Financial Services Innovation estimates the
annual demand for unsecured short-term credit to be about $61
billion, of which $8.5 billion was of overdrafts, $4.5 billion
of deposit advance products, which probably now will tend
toward overdrafts, Internet payday loans of $18.5 billion, and
storefront payday loans of $30 billion. The intent of this
study was to build a first of its kind analysis. This is the
largest data analysis commissioned by the industry to look at
what data was available, both from the specialty credit bureaus
as well as the lenders. We also wanted to comment on the
strengths and weaknesses of the data that was out there,
establish a baseline from which future annual updates can be
based, to try to provide an initial understanding of customer
demographics and loan usage patterns, and, of course, compare
this data to other research, such as Pew and CFPB in order to
add information to this discussion.
We analyzed over 60 million application records from the
three specialty credit bureaus. That included nine million loan
records over a 4-year period beginning in 2009. Because of
certain constraints, and I will be happy to talk about that
later, within the credit bureau data, we added an additional
1.6 million customer records from three lenders around the
country.
The key findings, for the most part, track closely with Pew
and CFPB. Of course, there are a few exceptions. In general,
the median age of the customer is 39, annual median income of
$30,000, and they are generally paid on a bi-weekly basis. The
average loan amount is about $400, but, I think, most
interestingly, is that average loan amount has increased from
2009, about $380, to over $530 in 2013.
The average annual number of loans range from two to four,
with 30 percent of customers having only one loan. This is
where we differ a little bit from the other studies, and part
of it is due to methodology and part of it is due to the data
that was available.
Annual days indebted range from 70 to 106 days, which
compares to Pew's analysis of 144 days and CFPB's analysis of
the storefront loans of 199 days.
Finally, loan performance from the credit bureaus indicate
71 percent of the loans were paid as needed, and 89 percent had
no charge-off flags.
I believe the growth in loan amount as well as the
intensity of usage characteristics has led to a trend of the
industry moving from the 2-week product to an installment
product. The installment product, I believe, will provide more
flexibility for the consumer and will lead to less cost for the
consumer. That said, I still think there is a viable need for
the 2-week product and that it fits within the continuum of
credit services needs in that the 2-week product is going to be
less expensive than an overdraft, and an overdraft is going to
be less expensive than returning a check insufficient.
Innovative companies, many of them operating exclusively on
the Internet, are trying to develop innovative products to
drive down cost. In my discussions with these companies, they
say the real innovation is limited because of the patchwork of
State laws that are out there. I believe Federal law is needed
to establish consistent rules and regulations to allow these
companies to innovate and drive down costs.
I notice an interesting quote from the Office of the
Comptroller of the Currency in 2011. I will paraphrase, but it
is that in the 21st century, the Internet and the advent of
technological innovations has accentuated the seamless--the
geographic seamlessness of financial services products. So, we
have let the genie out of the bottle. People can go on the
Internet, see what products are available, but they are
constrained by State regulations in terms of what products they
can get.
I believe H.R. 1566 is probably the best vehicle currently
available and enjoys close to 50-50 bipartisan cosponsorship to
allow customers access to credit on a national basis.
Thank you for your time, and I look forward to answering
your questions.
Chairman Brown. Thank you very much, Mr. Flores. Thank you
for staying within the 5 minutes, too. I appreciate that.
Ms. Klein.
STATEMENT OF STEPHANIE KLEIN, DIRECTOR, NETCREDIT CONSUMER
LENDING, ENOVA INTERNATIONAL
Ms. Klein. Good morning, Members. Thank you, Chairman
Brown, for inviting me here today. Again, I am Stephanie Klein.
I am a Director of Consumer Lending at Enova. We are a global
leader in online financial services, headquartered in Chicago.
I am really grateful for the opportunity to share some of our
experience with you today.
Senators, I am here to tell you about the exciting new
credit solutions we have been developing, what we have learned,
who we are serving, and how we can help underserved consumers
have equal access to quality credit. We believe we can change
the dynamics in the industry and provide a pathway toward
upward mobility that will benefit millions of hardworking
Americans who have been left behind by the traditional banks.
At Enova, since our launch in 2004, we have been using
advanced technology and analytics to create innovative products
that meet consumers' evolving credit needs. I oversee
NetCredit. NetCredit is one of Enova's newest installment
lending products for U.S. consumers. With NetCredit, customers
can borrow $1 to $10,000 and pay back over time in fully
amortizing installments over 6 to 48 months. Payment amounts
are typically just 6 to 8 percent of gross paycheck, and we
actually derived this ratio through rigorous testing of
customer behavior.
But just recently, we also released a new tool where
customers can actually vary their payment amount online, and in
real time, they can see the impact on the duration of the loan
as well as the total cost of borrowing as they customize their
payment. And interestingly, since we released this new tool, we
have seen that customers, on average, are self-selecting that
same 6 to 8 percentage of gross paycheck that we had calculated
and targeted historically. So, I think this is a true testament
to the power of the advanced analytics capabilities that we
have developed over the past decade at Enova.
Our customer demographic does present a unique challenge
when it comes to pricing. While NetCredit customers typically
have moderate incomes, usually ranging from about $40,000 to
$60,000, and they always also have an active bank account, they
have very low credit scores. Compared to the average U.S. FICO
score of 689, 90 percent of NetCredit customers score below
650, and the vast majority are actually below 600. So, we are
really serving a very high-risk borrower who traditional banks
are not willing or able to serve.
Our answer to this challenge is a unique risk-based pricing
algorithm. By leveraging multiple data sources and evaluating
literally hundreds of variables, we have been able to
successfully distinguish high-risk borrowers from lower-risk
borrowers and price accordingly. As a result of this
innovation, NetCredit's average interest rates are 50 percent
lower than other leading online lenders, and almost 75 percent
lower than a typical payday loan product.
Furthermore, because we use the simple daily interest
method, customers can save money by making early payments when
they have extra funds. There are no fees to our loans, simple
interest only, no origination, application fees, nothing up
front. So, I think this is a benefit, and, in fact, one-third
of our customers take advantage of this benefit and do choose
to pay back their loans early.
Over the past 2 years, we have been working hard to foster
relationships with the major credit bureaus. We have dedicated
significant resources to this effort and we are very excited to
help customers start building credit with these products. This
is a unique benefit that cannot be offered with 2-week
products, but is possible with longer-term installment loans.
Now that I have told you a little bit about what we are
innovating and some of the benefits we can offer our customers,
let me tell you about the significant challenges we face due to
the current regulatory landscape.
It is our belief that current State laws do not adequately
serve consumers. Instead of working toward innovative solutions
that can be scaled across 50 States, we are forced to develop
new products for individual States within the constraints of
antiquated consumer credit statutes that were never drafted
with current technologies or Internet lending in mind. In many
cases, instead of allowing customers a choice of quality credit
products, the State law actually forces customers into the
single-payment loan as their only option.
Our mission at Enova is to create high-quality innovative
products that can not only serve an immediate credit need, but
can also help customers achieve a better financial future. We
have proactively shared our experience with groups like the
Center for Financial Services Innovation and the CFPB's Project
Catalyst in order to promote discussion on how we can design
policies that help working families throughout the country
achieve equal access to credit. We envision uniform Federal
standards that enable innovation to meet the needs of today's
increasingly mobile, tech-savvy consumers. I encourage all of
you to support legislation to modernize our laws for the
benefit of the 68 million Americans in this country who do not
currently have sufficient access to credit.
Thank you, Chairman Brown, thank you, Committee Members,
for allowing me to be here and share this testimony and I look
forward to any questions.
Chairman Brown. Thank you, Ms. Klein.
Mr. Bourke.
STATEMENT OF NICK BOURKE, DIRECTOR, SAFE SMALL-DOLLAR LOANS
RESEARCH PROJECT, THE PEW CHARITABLE TRUSTS
Mr. Bourke. Thank you, Chairman Brown and Ranking Member
Toomey, Members of the Committee. My name is Nick Bourke. I am
with the Pew Charitable Trusts. We are a large 501(c)(3)
nonprofit organization. A big part of our mission is to
generate good quality research that helps inform good public
policy, and I would like to focus today on the research that we
have been conducting over the past 3\1/2\ years about payday
and small-dollar lending.
Payday lending, as, Chairman Brown, you outlined very well,
this is typically a 2-week balloon payment loan that is due
back in full on the borrower's next payday. Payday lending is
an experiment that began in the early 1990s in this country,
and the goal was to try to make more credit available to
financially fragile consumers. Unfortunately, this experiment
has not worked out too well.
When people get a payday loan, the only real requirements
are that they have a checking account and that they have an
income stream. If they have those, and the lender then uses
their unique power to leverage the checking account and gain
access to the borrower's checking account and income stream,
that acts--that stands in for the underwriting.
About 12 million people use these loans each year. Why do
they use them? Well, in Pew's nationally representative survey
of payday loan borrowers, where we called people throughout the
country and screened through about 50,000 people in order to
get enough payday loan borrowers to give in-depth interviews to
represent all borrowers across the country. We asked, what is
your financial situation, and what payday loan borrowers said,
58 percent of them, was they have trouble paying their monthly
bills half the time or more. And one-quarter of payday loan
borrowers said they have trouble paying their monthly bills
every single month.
Most have debt already. More than half of payday loan
borrowers have credit card debt. Forty-one percent own homes,
so there are mortgages. Many of them have student loans. Many
of them have auto loans. People are carrying debt. Almost all
payday loan borrowers have a credit score, and the average
score is 517. This indicates that people are already struggling
with debt. They are at the bottom of the barrel in terms of
credit score.
They are failing out of the mainstream credit system. They
are not trying to get into it. They have been there and they
are failing out. This is really important to remember when we
think about what is the right solution here and how can credit
help them or how can it not help them.
When we ask people, why did you get your payday loan, what
did you use the money for, 69 percent of borrowers said that
the reason they got their payday loan, unsurprisingly, perhaps,
was to help them pay their bills--rent, utilities, credit card
bills. Only 16 percent said that they turned to a payday loan
for some kind of unexpected expense, like a car breaking down
or a medical emergency.
So, this paints a vivid picture of financial struggle and
why people are turning to the loans. It also helps us
understand why this product, why this market is not serving
this consumer.
A payday loan typically requires a balloon payment of $430,
on average, out of the borrower's next paycheck. The typical
borrower is making about $30,000 a year. That is about $1,200
every 2 weeks. The payday loan is requiring them to sacrifice
one-third of their next paycheck toward a payday loan. That is
unaffordable and it is not working.
The message that I want to convey is there is a solution.
There is a way out of this. The status quo is not working. Pew
has recommended five policy recommendations to help address
this problem.
The first one relates to an ability to repay principle. The
payday loans are not working because they are fundamentally
unaffordable. The way to address this is to require lenders to
consider the borrower's ability to repay. If one-third of the
paycheck is too much to pay, what is the right benchmark? Our
benchmark, based on research, is 5 percent. Loans should not
take more than 5 percent of a person's paycheck unless the
lender is doing some really serious underwriting to make sure
that the borrower can afford it.
Number two, spread costs evenly over the life of the loan.
Simply turning the loans into installment loans is not going to
work. We need to have some simple safeguards to make sure that
the problems that we see in installment loan markets, with
frontloading of fees and interest, large origination fees,
giving incentive to refinance or flip loans, we need to protect
against those.
Number three, guard against harmful repayment or
collections practices. Generally, we need to make sure that
borrowers have a little bit more power, a little bit more
security to stop electronic payments in the face of
unscrupulous lenders or overly aggressive debt collectors.
Number four, concise disclosure so people can get good
information to make good decisions.
And number five, States should continue to set maximum
allowable interest rates because data suggests that the small-
dollar loan markets serving people with damaged credit are not
price competitive.
Pew has done a case study in Colorado where they
essentially implemented reforms along these lines in 2010, and
what we saw there is that it worked. Access to credit has been
maintained and borrowers are spending much less and being much
more successful with reasonably structured loans with sensible
safeguards.
Thank you very much.
Chairman Brown. Thank you, Mr. Bourke.
Mr. Rothstein, welcome.
STATEMENT OF DAVID ROTHSTEIN, DIRECTOR, RESOURCE DEVELOPMENT
AND PUBLIC AFFAIRS, NEIGHBORHOOD HOUSING SERVICES OF GREATER
CLEVELAND
Mr. Rothstein. Thank you. Senator Brown and Ranking Member
Toomey, I appreciate the opportunity to testify before you
today. Outlined in this testimony, I hope to convey the
importance of strong regulation around small-dollar lending,
particularly from the Federal Government, as local authorities,
such as my State of Ohio, continue to wrestle to ensure that
consumers receive safe and affordable loan products.
It is imperative, as Nick discussed, that we look at the
characteristics of the loan, such as APR interest and method of
payback, to assess the quality of the products. First, the
traditional payday loan model in Ohio is alive and, as in other
States, does not serve families well. Research of actual
borrowers continues to tell that story in numerous ways, even
in the report that was just released by the CFPB yesterday.
I say that it does not serve them well because the average
family takes out eight to 12 loans per year from one lender,
typically purchasing loans in back-to-back transactions. This
is absolutely the typical Ohio customer. This means as soon as
their loan is repaid, they immediately reborrow to cover other
expenses. This is also the prototypical discussion of what we
call the debt cycle.
Our housing and financial capabilities counselors in my
office indicate that most clients that have one loan have about
four other loans from other stores. Keep in mind that many
families cannot afford to pay back the principal balance of the
loan in just 2 weeks, let alone interest and principal. And if
payback does occur, other monthly budget items, such as rent,
utilities, food, and car payments, suffer. In sum, we see the
people after they have exercised their freedom to take out
these loans and they want out.
Second, payday lenders in Ohio have morphed into auto title
and installment lenders. This is quite typical and quite often
more expensive. In 2008, the General Assembly in Ohio passed a
bipartisan bill to curtail interest rates. The new APR was 28
percent interest. This is a significant reduction, since
lenders before had been charging 391 percent interest. Despite
spending at least $10 million in a ballot referendum to reverse
the decision, not a single payday lender in Ohio uses the
short-term loan act that was passed. Rather, they use two
antiquated mortgage lending laws to sell loans at essentially
the same price, if not more, than before.
Most recently, as I indicated, in Ohio, stores are selling
high-cost loans that use automobile titles as collateral rather
than a postdated check. An auto title loan is often more
dangerous than a payday loan in the sense that people can, and
do, lose their cars once they are too far into debt. I have
included in my testimony a three-part story from the Akron
Beacon Journal about a working mother of three who lost her car
and nearly her home after this loan. With the help of several
nonprofits and the writer for the article, she was actually
able to get her car back.
Installment loans, the newest payday product in Ohio, are
offered by payday lenders and they carry a similar triple-digit
interest rate and use the Credit Service Organization statute
to sell loans for up to 12 months. One loan that I analyzed
from a store about 5 minutes from our office cost a borrower
$5,000 to borrow $2,000 over a 12-month period.
Finally, at NHS of Greater Cleveland, we practice what we
preach. Since we advocate smart home ownership, we purchased
our building in the recovering area of Slavic Village, Senator
Brown's new neighborhood. Since we are notably critical of
payday lending, we are developing two alternatives. Working
with the innovative startup company Employee Loan Solutions, we
will be working with large employers to provide safe,
underwritten, low-cost loans through paychecks. The lender is a
CDFI focused on providing low-income families with affordable
financial products. There is underwriting. There is no
prepayment penalties and certainly no balloon payments.
The other program is a small-dollar loan serviced and
managed by NHS of Greater Cleveland. The intent is to comply
with Ohio's payday lending law of under 26 percent APR. We will
be much lower than that. We will be the only group in Ohio to
comply with Ohio's payday lending law.
As this Congress and Consumer Financial Protection Bureau
consider rules and regulations around small-dollar lending, a
floor on small-dollar loans will encourage high-quality
innovation. Nick mentioned their principles through Pew. I
would also recommend CFSI's principles around small-dollar
credit. They are also quite strong.
Lenders should be required to fully assess a borrower's
ability to repay a loan in full and on time without the need
and use of cashing a check or electronic debiting an account.
Just like mortgages or credit cards, ability to repay
requirements protect borrowers from unsustainable debt. The
litmus test for automatic payment should be that it is a
convenience for the borrower, not a sidestep for debt
collection laws.
I really do appreciate your time today and I am looking
forward to question and answer and I am happy to, again, answer
any questions that you may have. Thank you for your time.
Chairman Brown. Thank you, Mr. Rothstein.
Professor Martin, welcome.
STATEMENT OF NATHALIE MARTIN, FREDERICK M. HART CHAIR IN
CONSUMER AND CLINICAL LAW, UNIVERSITY OF NEW MEXICO SCHOOL OF
LAW
Ms. Martin. Thank you very much. Good morning, Chairman
Brown, Ranking Member Toomey, and other Members of the
Subcommittee.
As Senator Brown indicated, my research focuses on high-
cost loans, and I have done several empirical studies,
including one in which we interviewed real borrowers curbside.
I also work directly with consumers in our clinical law
program, and as a result have had a tremendous amount of
contact with actual borrowers of these types of loans. So, this
borrower contact, I believe, informs my testimony today in a
way that book research simply cannot.
As I understand the goals of the hearing today, they are to
identify fair, affordable access to credit for all, but fair
and affordable are not words that I would use to describe the
loans that are the subject of this hearing.
We have not talked too much yet about interest rates, but I
would like to do that for just a moment. Storefront payday
loans, I think, as Mr. Rothstein said, typically carry an
average rate of about 400 percent per annum and title loans
about 300 percent per annum, but, of course, there is the risk
of losing your car with those.
With the installment loans, though, that Mr. Rothstein
mentioned, that are generally designed to get around State
regulation, the rates can be much, much higher. For example,
one consumer that I know borrowed $100 and paid back $1,000
over a year's time. The rate on that loan is 1,100 percent
interest. And the important thing is that that loan is legal in
many States. That is a legal loan.
The biggest challenge we have, though, in terms of
regulating these forms of credit is in the area of online
lending. This is a growing segment. It is growing by leaps and
bounds. Those rates are higher than storefront payday loans--
800 to 1,000 percent is very typical--and there is very little
regulation of these online lenders. The SAFE bill that was
proposed by Senators Merkley, Udall, and others will be very
helpful, but I think it is also very important for the CFPB to
have as much power as possible to regulate that form of credit.
And on the topic of the CFPB, it is actually--as far as I
am concerned, nothing is more critical at this moment than
protecting the CFPB's ability to regulate this entire high-cost
loan industry all across the spectrum of small-dollar lending,
not just focusing narrowly on payday lending, because of the
loopholes that Mr. Rothstein talked about.
You know, I also have been watching very closely and
following every State law that has passed in order to curb
these lending practices and watching in nearly every State as
lenders find ways around the laws that pass. As new State laws
pass, other than interest rate caps, interest rates and fees do
not go down. Indeed, what happens is that they either stay the
same, or usually, they go up after the new law. And, no matter
how many lenders enter this market, no matter how many, the
rate does not go down. So, what we can see is that the market
is not working in this particular context.
And we heard from Ms. Klein about an Internet lending
company that may offer a new product that could be 75 percent
cheaper than existing online loans, or 50 percent cheaper than
storefront loans. Keep in mind, those would still be 200 to 300
percent loans. So, even if that is OK, my real bone to pick is
with the idea that somehow this Federal charter is going to
make the rates go down. That is not the history. If history is
any indication, additional freedom imparted on the industry
under this charter will only cause the rates to go up, or, at
best, to stay the same. In any event, any bill that is proposed
by industry, if looking at that, consider the compliance record
of the existing industry. Is this the place we want to look for
our solutions?
So, what are the solutions and the alternatives? We have
heard about some of them. One would be, of course, true
underwriting of the loans, meaning the lender has to determine
that the borrower actually has enough money to pay their
regular bills plus the loan or the loan is not enforceable.
Another very important thing, based upon the recent CFPB
paper that came out yesterday, would be to prohibit rollovers
and limit the numbers of loans through a national data base,
and that means if the lender did not use the national data
base, then the loan would not be enforceable.
I think both of those are viable options. If lenders feel
that this is too complex, there is always a much simpler
solution, which would be a Federal interest rate cap. And, by
the way, although I know not many politicians favor that, the
general public very much does favor interest rate caps, and I
have attached a paper to my testimony so indicating.
I guess the last thing I would say is I am very excited
about other options that are being developed in the
marketplace, the CDFIs that Mr. Rothstein spoke about as well
as the idea of having the U.S. Postal Service get into this
business.
Thank you very much for your time.
Chairman Brown. Thank you, Professor Martin, and all of
you, thank you for your trenchant testimony.
You may have heard from Senator Toomey's and my opening
statements that we have a sort of different view of this and
the role of Government, but I see some seeds of hope in Mr.
Bourke's testimony and Mr. Rothstein's attempts in Ohio, and I
hope there is a way we can get to some of these solutions for
the unbanked that Senator Toomey spoke about.
Let me specifically--I want to ask this directly to all of
you, starting with Professor Martin--the Pew studies--I think
there were three you did with some 50,000 calls to consumers,
so a pretty good cross-section of people--show that consumers
use payday loans even when they have cheaper credit liquidity
available to them. Forty-one percent eventually paid off their
loans using one of these options--credit cards, bank loans,
pawn shops, other short-term loans. Borrowers have chosen to
use payday loans when there is liquidity in their checking
account in many cases.
Mr. Rothstein describes two products that Neighborhood
Housing Services is developing. There have been reports about
other affordable small-dollar products. You mentioned some of
the examples in Colorado. Key Bank in Cleveland, a regional
good-sized bank--midsized bank in Cleveland--has offered a $250
to $1,500 line of credit with a 14 to 19 percent interest rate,
up to 5 years for repayment, two fees totaling $25. They say
this product can be profitable.
So, my question, starting with Ms. Martin and moving from
my right to my left, is why do borrowers use the high-cost
payday loans when there are, in many cases, alternative
affordable--alternatives available to them that are affordable?
What do these choices tell us about borrowers' behavior?
Ms. Martin. So, I think, initially, there is a confusion on
the part of borrowers about the rates. So, if they hear, oh,
the rate is $15 per $100, they think that is a 15 percent per
annum rate, even though it is only for 2 weeks. It is a 400
percent loan. And in my study, I found that there were people
who thought that was actually going to be cheaper than using a
25 percent credit card, for example. So, that is part of it.
Enumerancy, in general. You know, people cannot do math. That
is a problem that we have seen in society.
And I think people also look at these--if there is a lender
on every corner, they are thinking that is kind of a normal
thing to do, and I have even heard people say, ``Oh, no, I
would not use a credit card for that. Those are only for
emergencies.'' So, I think the advertising, the ubiquity of the
industry makes people think this is a better option somehow.
Chairman Brown. Mr. Rothstein.
Mr. Rothstein. I think Nathalie is right on. I think there
are two things, also, that our financial counselors have
noticed. One is a sense of optimism in that people are
generally feeling that in 2 weeks, they will be in a better
position than they are before, and a lot of this has to do with
just the nature of work and temp work and those kind of things,
and often, they are not.
And then the second thing is, I would argue, and I think
the Pew studies, the CRL studies have really shown, that after
the first or second loan is taken out, the choice to take out
other loans becomes dramatically reduced because they are going
to be short for their other expenses after they pay back the
loan or after the lender runs the check through that they have
postdated. So, I think the argument of after the first or
second loan how much of a choice it is is debatable.
Chairman Brown. Mr. Bourke.
Mr. Bourke. In our second report, we identified six reasons
why people use unaffordable payday loans, and one of them is
desperation. Thirty-seven percent of borrowers in our survey
said that they have been in such tight financial circumstances
that they would take any loan on any terms.
Other reasons relate to perception and reliance. A
consistent theme that we have heard in focus groups with
borrowers is that, hey, I already have enough debt. I already
have enough bills. I do not need another bill. I do not want
more debt. I have gotten in trouble with credit cards before. I
am just going to get this payday loan because it looks like I
can get in and get out quickly and I am not going to add
another bill to the pile. The reality, of course, is very
different.
There are several other reasons, but one thing I want to
point out, a good way to think about this and analyze it, I
think, is to compare what the product looks like or how it is
packaged to the reality of the situation. And in the
conventional payday loan market, the product is typically
packaged as a short-term product for unexpected expenses. In
fact, the industry will typically say, do not use these loans
for long-term use or anything more than a temporary need.
But the business model of payday lending is built on
extended usage and a lot of data shows this very clearly,
including the payday loan study that came out yesterday from
the CFPB. The vast majority of volume in the payday lending
market, the vast majority of revenue comes from people who use
the loans repeatedly over an extended period of time. And if
most borrowers--or, I should say, if borrowers used the loans
as packaged, the business model of payday lending would fall
apart. It is absolutely reliant for its profitability on
extended usage.
Chairman Brown. Thank you.
Ms. Klein, is he right that your products from Enova and
other companies are packaged for short-term one-time loans, but
the model is something--your business model is something
different?
Ms. Klein. So, just to be clear, I do not run a payday loan
business. I mean, my product is an installment loan. I cannot
speak for others in the industry. What I can say for Enova is
that we proactively in every State where we can have been
moving toward longer-term loans. What I really like about the
installment loan is under its Federal regulation, there are
clear and transparent disclosures up front. So, when a customer
borrows from us, they see the principal amount, they see the
APR, they see the total finance charge in dollars, which may
make more sense to a lot of customers than an APR calculation,
and they see the payment amount.
So, really, in my opinion, you know, why do customers use
these products? Because there is a need that is being unmet. If
these other solutions people talk about were meeting the need,
the products would not exist. So, there is absolutely a need
and what we need to focus on is how do we bring higher-quality
products to market at scale so that the millions of Americans
who need them have access.
Chairman Brown. Mr. Flores, you have had the Online Lenders
Alliance. You have done studies for them. Is Mr. Bourke right
about that, that the packaging for short-term one-time loans is
different from the actual business model?
Mr. Flores. Well, Senator, what I have tried to do with our
studies is build data for the analysis of their product and how
customers use their product. I have not done specific work for
vendors or lenders within that industry. So, I cannot really
comment on the business model versus the product.
Chairman Brown. OK. Senator Toomey.
Senator Toomey. Thanks, Mr. Chairman.
Ms. Klein, we have heard just now the characterization of
the lending that goes on in this industry, the ideas that there
is indiscriminate lending. Basically, if you have got a bank
account and a job, you get a loan. There are balloon payments.
People do not consider--lenders do not consider a customer's
ability to repay. Did it ever occur to you to consider a
customer's ability to repay, or are you indifferent to getting
your money back?
Ms. Klein. Thank you for asking that question. That is a
great question. You know, obviously, if our customers cannot
pay, we do not make money. So, if our customers are not
successful, we are not successful.
Just to give you a little insight--again, I cannot speak
for everyone in the industry, but as to how NetCredit evaluates
that--we are spending a lot of money, typically $30 to $50 per
funded customer, on underwriting. We are pulling prime data, a
Vantage score, you know, similar score from a prime bureau. And
we are also pulling alternative data from about five different
data sources. So, we use all of this data up front to try to
come up with a loan offer that would be appropriate.
Additionally, after a consumer expresses interest in that
product, we are doing some sort of verification for everybody.
Nobody gets an auto approval on the NetCredit loan. So, we are
checking employment. For a lot of people, we are looking at
bank statements. Because we are online, we are verifying
identity. We do a ton of verification, and as a result of that,
our approval rates are typically only 15 to 20 percent. So,
this is not walk in, fog up a mirror. I do not know how you
would do that in the online metaphor, but----
Senator Toomey. So you----
Ms. Klein. ----but that is not how we do our business.
Senator Toomey. To be clear, so, you are rejecting
applications from 80 to 85 percent of the applicants because
they do not meet your credit standards?
Ms. Klein. Correct.
Senator Toomey. Is that----
Ms. Klein. We reject 80 to 85 percent, and additionally,
just to kind of speak on, well, these customers are desperate,
not every customer that we approve chooses our product. And we
see, especially online, it is much easier to comparison shop--
--
Senator Toomey. So, there is competition.
Ms. Klein. and so once you make an offer, at least 40
percent of people typically walk away, and that is fine, and
they are looking for the right choice for them.
Senator Toomey. So, you are not able to set any old rate
you like, because if you do, someone else who competes with you
will set, presumably, a lower rate and competition imposes a
discipline in this space. Is that a fair----
Ms. Klein. That is absolutely correct, and I would say,
really, it has been recent, but in the past year, especially in
the online space for installment lending, we have seen prices
come down. I would like to think that NetCredit was one of the
first lenders to start driving that effort, but we have
actually seen other lenders innovating in the same way. And so
I think competition can work online.
Senator Toomey. It seems obvious to me, but just maybe you
could confirm. The kind of underwriting you do would not have
been possible, certainly, 10 years ago, probably not even 5
years ago, but advances in technology and access to data and
evolving techniques have made this kind of underwriting
possible recently.
Ms. Klein. That is absolutely true. I mean, I will not
waste too much of your time, but I could list off a ton of
tools, data vendors that are available today that were never
available historically, and we are constantly testing with new
vendors. There is not a day that goes by where, in addition to
the data we already use, we do not have a few other vendors
where we are doing a retro study, we are saying, hey, here is
some data, give us your data. How can we do better? How can we
get smarter about underwriting? It is an ongoing effort.
Senator Toomey. Thank you.
Mr. Flores, I wanted to ask you a question and ask you to
describe a little bit to us a program which, I think, has a
name, called Operation Choke Point, if I have that right. My
understanding of this is a systematic effort on the part of
some bank regulators to pressure banks into not providing
ordinary services to the short-term lending industry as a way
to indirectly shut down this industry. Despite the fact that
the industry is operating in a perfectly legal fashion and they
might be very good and, in fact, profitable customers for the
bank, it seems that some regulators believe that without any
Congressional authority, they ought to be able to shut down an
industry because they do not like it. Do I have that roughly
correct, and could you----
Mr. Flores. Yes, sir----
Senator Toomey. ----describe what is happening here?
Mr. Flores. ----that is correct. I believe what they have
done is take what would be a shotgun approach. I mean, many of
the lenders who are licensed in the States to operate are
operating in a legal business environment and I do not see the
cause to restrict them from access to the payment systems to
conduct their business. Now, yes, there are unlicensed offshore
vendors and I think that a more targeted approach to address
the unlicensed operators would be much more appropriate in
dealing with the bad actors than just shutting down an entire
industry.
Senator Toomey. And, finally, if we had a new regulatory
regime that forbids categories of transactions and puts
Government dictated pricing limits on these transactions, is
there any chance that some people who currently need and get
access to credit will no longer have that access to credit?
Mr. Flores. Absolutely. It is the nature of price controls.
The 36 percent annual APR has been talked about a lot. In
small-dollar lending, particularly to a high-risk customer
group, given the cost of originating, servicing these types of
credits, you cannot properly make those loans. Banks have
gotten out of the business of small-dollar unsecured consumer
credit, probably 15, 20 years ago when they migrated to credit
cards and then overdrafts and then home equity lines of credit.
So, it is a real problem.
The deposit advance program is an example. That is close to
$5 billion of credit. And I talked to some people that were in
the industry in those banks that say it is probably actually
closer to $10 billion, but you see FSI's number of $4.3 billion
of credit extended. That has gone away. The demand has not been
ameliorated.
Where does that go? Well, if these customers are customers
of those banks that offered the product, the next likelihood
for them to do is then the overdraft, which is going to be a
much more expensive option than that deposit advance product.
So, you limit supply of certain products, you are going to
force customers--unless you somehow deal with the demand, you
are going to force customers into products that are not
suitable for them.
Senator Toomey. Thanks very much. Thank you, Mr. Chairman.
Chairman Brown. Thank you, Senator Toomey.
Senator Warren.
Senator Warren. Thank you, Mr. Chairman. Thank you for
holding this hearing.
So, there are 34 million families in the U.S. that are
unbanked or underbanked, meaning they rely on check cashing, on
payday lending or other financial services outside the
traditional banking system. The cost for these families is
huge. The average underbanked family makes about $25,000 a year
and it spends about $2,400 a year just on interest and fees for
basic financial services. In other words, that is nearly 10
percent of their annual income, about the same amount that they
spend on food.
Now, a primary reason that they spend so much is they
cannot get to bank branches. It is a lot harder to open a
savings account or a checking account if there is no branch in
your area, and banks are rapidly abandoning low-income and
rural neighborhoods. According to SNL Financial, a research
firm, banks are systematically closing their branches in areas
where the median income is under $50,000 at the same moment
that they are opening more branches in areas where the median
income is over $100,000, and that trend is expected to continue
in coming years.
So, a couple of months ago, a report from the Inspector
General of the U.S. Postal Service recommended that the Post
Office partner with banks and credit unions to provide basic
financial services--check cashing, small-dollar savings
accounts. With Post Offices in every ZIP code, that would solve
the access problem. In fact, 58 percent of Post Office
locations are in ZIP codes with zero or one bank branches. The
Post Office could leverage its infrastructure to ensure that
low-income families have both access to banking services, that
rural families have access to banking services, and that those
services are offered at a lower price.
So, what I want to ask is, Professor Martin, do you think
that partnering between the Postal Service and banks and credit
unions could be a better way to serve low-income and rural
communities and do it at a lower cost than the current
alternatives?
Ms. Martin. I do actually think that this is a viable
alternative. I think there are just a couple of things to keep
in mind. One, in the report, the Inspector General indicates
that a couple of sample studies or small, you know, start in a
couple places first, see how it goes, see how the profitability
goes. It is very important that those be started in areas
without storefront payday loans so that there is no issue about
the hours and those kinds of things.
And the other thing, of course, is who will be the partners
and what will be the rates. But, assuming that the rates will
be cheaper, as indicated in the report, I think this is a very
viable alternative that should definitely be pursued.
Senator Warren. Mr. Rothstein, would you like to comment on
it?
Mr. Rothstein. Sure. Thank you, Senator. So, I think
Professor Martin is right. I think the implementation phase
would be the challenge. I think, theoretically, it makes sense,
and it is actually done in Japan and Germany and other
countries, which--the biggest hurdle, I think, besides
implementation, would also be just sort of the--and we have
heard some of those opinions just even recently, yesterday in
Nashville and then here today, about the hostility toward the
idea of the Government sector being involved in providing
loans. So, I think that is the biggest hurdle.
Senator Warren. OK. Mr. Bourke, do you wish to comment on
this?
Mr. Bourke. We are interested in the issue. We have not
conducted research on it, but it is an issue we are interested
in researching more.
I would like to say a more general comment about why
millions of people today are opting or looking outside of the
banking system for something that the banking system is not
giving them. So, I will focus specifically on some research we
recently published about prepaid debit card usage.
We found that the people who use general purpose reloadable
prepaid cards, these are essentially checking accounts without
checks. People can buy them on J-hooks in drug stores and use
them as bank accounts. The driving factor of why people are
using prepaid cards is to gain more control over their finances
and to gain shelter from overdraft fees and the temptations of
credit. People are seeking commitment devices to help them only
spend the amount of money that they have and not get into
trouble with credit and overdraft fees. Prepaid cards are
giving that to them right now because, by and large, prepaid
cards do not allow overdraft or spending more than people have.
And what we found, interestingly, is that seven out of
eight prepaid card users either currently have or used to have
a bank account. So, people are actually experienced in the
banking system and they are starting to go outside of it.
So, whether it is the Postal Service or anything else, I
would say this is a very important finding because we are
seeing people looking for something that they are not getting
from the banks, and I think we should keep this in mind when we
are thinking about what the services are going forward.
Senator Warren. Thank you very much. I see that my time has
expired, and I just want to say, I think this gives us an
opportunity to expand access, an opportunity to create some
real competition here, and an opportunity to think more
creatively about how it is that people of moderate income, how
it is that people who live in rural areas get access to the
banking services that they most need. And so I appreciate the
comments on this.
Thank you very much, Mr. Chairman. It looks to me like we
have a win-win here. I would like to take advantage of it.
Chairman Brown. Thank you, Senator Warren.
Senator Heller.
Senator Heller. Mr. Chairman, thank you and thanks for
holding this hearing. I appreciate all of you being here and
listening to you and the expertise that you bring to the table.
Last week, the Fed Chair came out and said that one of the
reasons that the economy is struggling to recover is because
many households have limited access to credit, either because
of their credit histories or the value of their homes being
underwater. So, for many people, traditional banking products
are not available to them, and it cannot be more true than in
the State of Nevada right now, where, unfortunately, we need
the Nation in foreclosures, short sales, and bankruptcies. So,
we have alternative financing quite available in the State.
Ms. Klein, I have a couple of questions for you. Customer
satisfaction--what is the customer satisfaction on your
product?
Ms. Klein. Sure. So, we survey our customers once a month
for all of Enova's products. We consistently see greater than
90 percent satisfaction. We also see that nine out of ten would
recommend this product to a friend, and that is saying a lot
because people do not always want to talk about credit and how
they are accessing credit. So, customers are very grateful for
the products we provide and very satisfied with the service.
Senator Heller. What is your percentage of return
borrowers?
Ms. Klein. So, for NetCredit, because we are doing longer-
term loans and we actually just launched this business in 2012,
I do not have a lot of data on that. Our average loan is about
20 months. But, again, the loans are structured so that these
customers can repay over time. I think we have talked a lot
about the lump-sum payment. That can be difficult for some
consumers, so we are trying to provide another option out
there.
Senator Heller. OK. Alternative financing--can that help an
individual's credit score?
Ms. Klein. Absolutely. A product like NetCredit can. So,
typically with a payday product or a 2-week product, the
bureaus will not accept that data. So, at TransUnion and
Experion and Equifax, even if you wanted to report performance
data, they will not take it. They do not see it as relevant to
their main customer who is a bank who wants to know if they
should write a mortgage loan or an auto loan or a student loan.
But, with these longer-term installment loans, the bureaus
are happy to take that data, and we now have contracts with all
three bureaus to start reporting our data. Again, these people
have very low credit scores. I think you quoted a 517 or so
average. We see that same, you know, 500 to 650 range. I think,
without these products, people have no way to build back. So,
this can be a starting point. These installment loans can get
people back into the system, build credit with the major
bureaus, and that way, they can access banking products in the
future.
Senator Heller. Do you have any success stories? We hear
all the horror stories. Do you have any success stories of
people avoiding foreclosures, losing their cars?
Ms. Klein. You know, I get emails all the time, so we
actually have a feedback email, and I have that set to go
directly to my inbox because I want to see firsthand the
customer feedback, and definitely, we have customers all the
time who email us. I would say, as our business grows, it is
starting to be about one a day, and so I look forward to those
emails. And people tell us, hey, this product was really a
lifesaver. You know, without this product, I do not know what I
would have done.
Another thing that is interesting, everyone talked a lot
about monthly bills, and one comment I want to make, you know,
we do ask customers how they use the product, and sometimes
people will say monthly bills. And then when you ask a little
further, they say, well, you know, my mom was really sick and
she was in the hospital and I had a lot of medical bills, blah,
blah, blah. Now, 6 months later, I am having a hard time paying
my rent.
So, when people say ``monthly bills'' and you stop there
and you do not ask, what was really the cause, a lot of times,
we see it was unexpected expenses. But what they need the money
for today is their rent. And so when they say monthly bills,
what they really mean is something happened a week ago, a month
ago, or 2 months ago that drowned my savings, and because of
that, I now need to borrow.
Senator Heller. Ms. Klein, thanks for you comments.
Mr. Chairman, I have no further questions.
Chairman Brown. Thank you, Senator Heller.
Senator Merkley.
Senator Merkley. Thank you very much, Mr. Chairman.
Mr. Flores, you argued in support of, I think it is H.R.
1566----
Mr. Flores. Yes, sir.
Senator Merkley. ----which essentially strips State laws.
In Oregon, we have a 36 percent cap, and we put it in place in
2007. Since then, the citizens of the State have the access to
those loans that, with the up-front fees, the annualized
interest rate may be higher, but, essentially, on a longer-term
rollover--because you can only use the fees once--the cost is
much, much less than before. So, they still have access to
credit, so there is no access to credit issue here. They just
get it at a much, much cheaper price. So, why would anyone in
Oregon want to roll back those State provisions, as you
suggest? Maybe you could just give one or two very short points
of why an Oregonian would want to go from a 36 percent cap to
no limit.
Mr. Flores. I do not think the bill precludes that
companies could not offer----
Senator Merkley. There is no cap in the bill, right?
Mr. Flores. Pardon me?
Senator Merkley. The bill--there is no cap in the bill.
Mr. Flores. That is correct. What I want to say----
Senator Merkley. Why would anyone in Oregon want to go from
a 36 percent----
Mr. Flores. I think a national charter would not preempt
local companies from abiding by the Oregon statute. My point is
choice. If the customer wants to use that product, that is
fine. But the issue is the Internet. They can go out there and
see other products that are available, and with the advent of
that, these boundaries, these State boundaries really have gone
away----
Senator Merkley. Thank you very much. I did not see
anything in there that explained why someone would choose a 500
percent loan and why they would want access to that when they
have the advantage of a much lower interest rate currently.
Ms. Klein, you said you do not offer payday loans, so I
went to your Web site here on the old pad and it immediately
says up-front, payday loans. Why did you testify that you do
not offer payday loans?
Ms. Klein. So, I believe my specific words were that I do
not operate our payday loan business. Enova has multiple
products. My area of expertise----
Senator Merkley. I see.
Ms. Klein. ----and the business that I have been running
for 3 years is NetCredit----
Senator Merkley. OK.
Ms. Klein. ----which does only offer installment.
Senator Merkley. So when I see--go to Enova and I see a
payday loan, and I checked a 14-day loan it is 683 percent, you
do offer payday loans, but you also offer this new product in
installment loans.
Ms. Klein. Correct. You know, Enova is actively moving and
has actually transitioned several States in the past 2 years
from payday loans to installment loans. But, we are so limited
by State law that in some States, we are forced to offer just
that 2-week solution, and that solution does not help people
build credit----
Senator Merkley. OK. All right.
Ms. Klein. ----so, it is a shame, in my opinion, but it is
what we have to work with.
Senator Merkley. Thank you very much. I found it very
interesting that when we were debating putting a cap on payday
loans in Oregon, the same arguments were made, that, somehow,
citizens would feel they wanted more choice, the choice to have
interest rates that drive them into a vortex of debt and drives
them into bankruptcy. But, amazingly, since we passed this law
in Oregon, I have never heard one Oregonian say that they are
unhappy with the law, because they get the same access to
credit but at phenomenally lower rates.
I was very struck by going to a food bank and having the
director of the food bank say--the first thing she said to me
was, ``Thank goodness you passed that bill, because we used to
have a stream of people coming to the food bank who were driven
into bankruptcy by payday loans and now we do not.''
If we can phenomenally increase the quality of life for
millions of people across this country, why do we not do it? We
have done it in Oregon. Why do we not do it across this
country? Why would we possibly consider savaging State laws
that--State laws that have improved the quality of life for
millions of citizens?
I want to tell you, the main thing I am concerned about is
the opposite, and that is the effort of folks to exploit
loopholes to continue to offer extraordinarily high interest
loans in States that have deliberately put caps into place. We
heard about Ohio. Well, in Oregon we covered all consumer loans
and, therefore, what we see is the two loopholes are basically
Federal chartered organizations that can bypass the State laws,
and second of all, we see online lenders who illegally take
payments out of Oregonians' bank accounts through remotely
generated checks and through electronic funds transfers. So,
the SAFE Act that Senator Tom Udall and I are championing stops
these predatory practices.
Mr. Bourke, should not a person have control over their
bank account in order to make sure that folks violating Oregon
State law not just reach in and take their funds away from
them?
Chairman Brown. And Mr. Bourke, answer very quickly. There
are 10 minutes left in the vote and I want both Senator
Menendez and Senator Vitter to get close to their 5 minutes, so
give us a quick answer.
Mr. Bourke. Absolutely. Online lending is growing, but it
is not growing because of State regulation. Online lending is
at the same level in all types of States, regardless of whether
payday loan stores are there. That is one point I wanted to
make.
Two, yes, we have seen in our research, and we will be
publishing on this in the coming months, that in online lending
especially, there is a big problem with people losing control
of their banking accounts, being subject to unscrupulous
lenders in some cases, aggressive debt collectors, and in some
cases fraudsters who purchase information from lead generators.
Senator Merkley. Thank you very much.
Chairman Brown. Senator Menendez.
Senator Vitter. We are not----
Chairman Brown. I am sorry. Senator Vitter, and then
Senator Menendez.
Senator Vitter. Thank you, Mr. Chair. Thank you all for
being here.
First, I want to say that I am absolutely supportive of all
efforts to enforce the law, Federal law, State law, to cut out
any abuses, any predatory practices. However, having said that,
I am very concerned that that has expanded to an overall effort
to shut down that entire industry, whether folks are following
the rules or not. And I have heard many documented examples of
that that really raise my concern.
So, I wanted to ask Mr. Rothstein and Ms. Martin in
particular, have you heard of Operation Choke Point and do you
think it is a broader effort and has morphed into a broader
effort to shut down folks in that space, whether they are
following law and the rules or not?
Ms. Martin. I actually am not familiar with it. I am sorry.
Senator Vitter. OK.
Mr. Rothstein. Senator, I had never heard of it until it
was mentioned this morning. I will say, though, that in Ohio,
we have, as I testified earlier, we have about four different
competing different loan acts that are being used and I think
it would be hard to argue that the one that lenders are using
the most in the storefronts, which is called the Ohio Second
Mortgage Lending Act, which was designed for mortgages, makes
sense for payday lending.
Senator Vitter. OK. Let me go back to my concern. I have
talked to a number of banks who have said their regulators are
coming and telling them not to service folks in that sector, to
stop that. And let me submit for the record an email that makes
this point. This is from a bank to a customer who is in that
business, and the relevant part is this. Quote, ``Based on your
performance, there is no way we should not be a credit
provider. Our only issue is, and has always been, the space in
which you operate. It has never been the service that you
provided or the way you operate. You have obviously done a
brilliant job. It is the scrutiny that you and now that we are
under,'' close quote. So, I would ask to submit this for the
record.
Chairman Brown. Without objection, so ordered.
Senator Vitter. I also submit for the record a similar
email, again, from a bank to a customer, saying, we cannot work
with you anymore. And it gets the same message across in
somewhat more scrubbed, less direct language.
Do you support regulators pushing banks to not service
anyone in that space, irrespective of whether their customers
in that space are following the rules or not? Mr. Rothstein.
Mr. Rothstein. Yes. So, Senator, the----
Senator Vitter. It is a yes or no, and you can elaborate--
--
Mr. Rothstein. I just want to make sure I understand your
question.
Senator Vitter. Yes.
Mr. Rothstein. So, you are asking, do I support the
restriction of capital----
Senator Vitter. Do you support regulators pushing their
regulated banks to cutoff credit to these customers,
irrespective of whether these customers in that particular
space are following the law, following the rules, or not?
Mr. Rothstein. I would have to look at it more.
Senator Vitter. So that is a close question to you.
Mr. Rothstein. I just would have to look at the issue----
Senator Vitter. Ms. Martin.
Ms. Martin. Yes, I am really not sure, either, because I do
not know--without any facts, I cannot answer it. Sorry.
Senator Vitter. Well, it was a pretty straightforward
question. I find it very troubling that banks are being
strongarmed to cutoff credit, to cutoff a lifeline to these
businesses, even if these businesses are following the law.
There is no issue in these two cases and many other cases that
they are not following the law, they are not following the
rules. There is a determined effort from DOJ to the regulators
to simply cut people out of that space, to cutoff their credit,
to use other tactics to force them out of business.
I find that deeply troubling, in part because it has no
statutory basis and no statutory authority. We have rules. We
should have rules. Maybe we need additional rules--we should
debate them--about preventing any abuse, any predatory
practices, et cetera. These are cases that do not involve any
of that.
Thank you.
Chairman Brown. Thank you, Senator Vitter. The basis is
safe and sound practices, ultimately, and I would think that is
where the regulators are looking here.
Senator Menendez.
Senator Menendez. Thank you, Mr. Chair. I think this is an
incredibly important hearing.
I have many of the concerns some of my colleagues have
expressed, but I also look at the FDIC report that says that
one in 12 American households is unbanked, meaning they do not
have a checking or savings account at an insured depository
institution. One in five American households is considered
underbanked, meaning they have access to a deposit account, but
they also rely on alternative financial services, such as
nonbank check cashing or lending places. Together, these groups
account for about 34 million households, about 61 million
adults. That is about 20 percent of the American population.
So, while I am concerned about their access to credit and
to capital and to be able to get access to the monies that they
need to get by and the terms under which they borrow, I am
mostly concerned that I have not heard any real meaningful
efforts to create the access that these individuals need. I
have heard reforms to the existing system, but I have not heard
about alternatives, and that is concerning to me.
The other thing that is concerning to me is that I know in
my home State of New Jersey, in fact, we have thousands of
people who go online to borrow money, but these are entities
that are offshore, which means there is no regulatory process
in the United States that is supervising that.
So, Mr. Flores, with reference to that legislation that
exists over in the House about creating a national charter for
online short-term loans, what would that do both to the
question of those who are offshore and the question of access
to credit for people?
Mr. Flores. Well, I think it would certainly help eliminate
that offshore unlicensed question. But to your point on folks
in New Jersey, the analysis we did of the 60 million
applications, the top ten States are 20 percent of the States
in the country, 56 to 63 percent of applications came from
those top ten States. Five of those States, including New
Jersey, New York, North Carolina, are States that prohibit or
limit payday loans or other short-term credit. So, the demand
is there. As you are saying, people are going online, looking
for the product.
I think a national product with defined rules and
regulations will benefit consumers such as your constituents in
New Jersey and others where State law inhibits their ability to
gain access to credit.
Senator Menendez. Ms. Klein, what is--I think we have a
good understanding of traditional short-term or payday lending
models that have existed in States for years, but I am curious
to know of any innovations to changes to loan products that may
create more flexibility for consumers and at the same time help
them to build credit histories that will move them toward more
mainstream banking. Is there anything that your company does,
or are you aware of others in the industry? And I am happy to
listen to others, as well.
Ms. Klein. Absolutely. Thank you for that question. And I
really think the NetCredit product that Enova offers
exemplifies what you are looking for. So, we have risk-based
pricing. It is not a one-size-fits-all model. We can actually--
we have the analytics and we have put the technology in place
to distinguish high risk from low risk and price accordingly.
We are giving customers the control to customize their payment
amount, and again, in real time, as they change. If they want a
lower payment, they see that tradeoff of it is going to take
you longer to pay back and you are going to pay a higher total
cost. So, giving the consumer transparency, power, control over
designing their loan.
Credit building that you hit on is one of the most
important pieces, and again, these short-term products that are
2 weeks, I think they serve a place in the marketplace for some
people. I think they are an appropriate product if someone can
afford to pay back in full. We have seen a lot of data that
that is not the case for everyone. And so for those consumers
who are looking for larger loan amounts and longer term, a
product like NetCredit would be great.
The issue is, we are only in 12 States today. There are
more States where you can offer a viable payday product that
everyone here is saying is not ideal for a lot of people than
States where you can offer a product like NetCredit that can
build credit.
Senator Menendez. Realizing that we have a vote on, I am
going to yield the balance of my time so that my colleague----
Chairman Brown. Thank you.
If you want to do one question, Senator Moran. Thanks for
the work on prize-link savings you are doing, and, I mean, one
really quick question, because the vote is imminent.
Senator Moran. Mr. Chairman, thank you very much. I was not
expecting you to be so considerate, but this hearing is
important. I have three going on at the same time this morning.
But I wanted to, in listening to Senator Vitter, I would
associate myself with his remarks. I do not understand why
Members of Congress do not see this action by DOJ and banking
regulators as a terrible intrusion upon Congressional
authority. If there is a problem in this space, as Senator
Vitter said, this is a matter to bring to Congress and for us
to determine what the laws should be, what the regulation
should ultimately result from that law. And so I miss the days
in which there were Members of Congress who spoke for the role
of Congress in making policy decisions as compared to deferring
to regulators, and particularly in this case, to a regulator
who is using their tremendous authority over financial
institutions to choke off access to credit to an industry that
is currently legal.
So, this whole thing just is terribly troublesome to me on
a broad philosophical point of view, and I would say that we
have agreed to sponsor legislation for Federal regulation of
this industry if we can find colleagues in this Committee and
elsewhere to join with us in that effort, and so if there is a
problem, let us make certain that Congress plays its
Congressional role.
Mr. Chairman, thank you for the opportunity to speak.
Chairman Brown. Thank you, Senator Moran.
Thank you to the whole panel. The vote is imminent, and
Senator Moran and others, including I will do the same, will
submit questions to you, and please get to us the answers as
quickly as you can. Thanks for your input, and a good hearing.
Thank you.
The Committee is adjourned.
[Whereupon, at 11:18 a.m., the hearing was adjourned.]
[Prepared statements, responses to written questions, and
additional material supplied for the record follow:]
PREPARED STATEMENT OF G. MICHAEL FLORES
Chief Executive Officer, Bretton Woods, Incorporated
March 26, 2014
Good morning, Chairman Brown, Ranking Member Toomey, and Members of
the Subcommittee. I am grateful for the opportunity to speak with you
today on the issues of consumer credit and discuss the results of a
study my firm recently completed on the customer and loan usage
characteristics of online short term loans.
I have worked in banking and consulting for more than 30 years and
in the past 15 years I have conducted research short-term consumer
credit including overdrafts and payday loans and studied prepaid cards
for the last 6 years. I am also on the faculty of the Pacific Coast
Banking School at the University of Washington where I teach a retail
banking course.
Based on my most recent research which was commissioned by the
Online Lenders Alliance and analysis of other studies, the need for
short-term, low dollar products is real and the demand is growing.
The Center for Financial Services Innovation estimates the
underbanked annual demand for unsecured short-term credit to be more
than $61 billion with:
Overdrafts accounting for $8.3 billion (from a total of
$38.3 billion in total overdrafts extended);
Deposit advance of $4.3 billion which, in my opinion, will
now move to overdrafts given the exit from this market by six
large banks;
Internet payday of $18.6 billion and Storefront payday
equaling $30.1 billion.
The intent of the study was to:
Build a first of its kind analysis within the industry to
understand the data that is currently available from the
specialty credit bureaus and lenders;
Understand the strengths and weaknesses of the currently
available data;
Establish a baseline from which an annual update is
planned;
Catalogue and understand customer demographics and loan
characteristics;
Compare this data with all other available data including
the Pew study and the CFPB report on storefront lending in
order to add information to the discussion.
We analyzed:
60 million application records and nine million loan
records from three specialty credit bureaus for a 4-year period
beginning in 2009.
Because of certain constraints in the credit bureau data,
we augmented this with 1.6 million customer records from three
lenders and four loan portfolios.
The key findings track closely with Pew and CFPB with a few
exceptions:
Customer median age is 39 with an annual income of
$30,000 and is primarily paid bi-weekly;
The average loan amount was $388 with a range from $300
to $500 with the average loan amount increasing each year from
$380 in 2009 to $530 in 2013;
The annual number of loans ranged from two to four with
the 30 percent of the customers with only one loan;
The annual days' indebted range from 70 days to 106 days
as compared to the Pew research of 144 days and the CFPB
storefront analysis indicating 199 days of indebtedness.
Finally, the loan performance data from the credit
bureaus indicate that 71 percent of loans were reported as paid
and 89 percent had no charge-off flag.
I believe the growth of the loan amount as well as the intensity of
usage measures has led to an important trend in the industry's move
from a 2 week product to an installment product with longer terms.
These installment loans should be less expensive than the
traditional 2 week product. That said, there is still value in the 2
week product because it fits into a continuum of credit services and is
usually less costly than overdrafts which are less costly than returned
NSF items.
Innovative companies, many of them operating exclusively on the
Internet, are trying to design flexible products to meet that demand.
The emergence of peer to peer lending is another example of this trend.
In my discussions with many of these companies, they say real
innovation is limited because of the patchwork of legacy State laws
governing access to short-term credit products.
Federal law is needed to establish the rules and regulations
necessary to provide access to credit for consumers nationwide and
allow companies the regulatory certainty they need to meet this growing
credit need and to innovate and drive down costs. H.R. 1566 is designed
to address this concern. The bill may need some work, but it has close
to 50/50 bipartisan support in the House and offers the best current
vehicle in Congress to help consumers.
Thank you for your time and I look forward to answering your
questions.
______
PREPARED STATEMENT OF STEPHANIE KLEIN
Director, NetCredit Consumer Lending, Enova International
March 26, 2014
My name is Stephanie Klein, and I am a Director of Consumer Lending
for Enova, a global leader in online financial services headquartered
in Chicago. Thank you for the opportunity to share Enova's experience
before this Committee.
Senators, I am here to tell you about the exciting new credit
solutions we have been developing, what we have learned, who we are
serving, and how we can help underserved consumers have equal access to
quality credit. We believe we can change the dynamics in the industry
and provide a pathway toward upward mobility that will benefit millions
of hardworking Americans who have been left behind by traditional
Banks.
At Enova, since our launch in 2004, we have been using advanced
technology and analytics to create products that meet consumers'
evolving credit needs. I oversee NetCredit, one of Enova's newest
installment loan products for U.S. consumers. With NetCredit, customers
can borrow 1 to 10 thousand dollars and pay back in fully amortizing
installments over 6 to 48 months. Payment amounts are typically just 6
to 8 percent of gross paycheck. We derived this ratio through rigorous
testing, but we have also released a new tool where customers can vary
their payment amount and see the impact on total duration and total
cost of borrowing in real-time.
Our customer demographic presents a unique challenge when it comes
to pricing. While our customers typically have moderate incomes,
usually ranging from 40 to 60 thousand dollars per year, they also have
very low credit scores. Compared to the average U.S. FICO score of 689,
90 percent of NetCredit customers score below 650, and the majority
fall well below 600. In short, we are serving very high-risk borrowers
who traditional Banks are not willing or able to serve.
Our answer to this challenge is a unique risk-based pricing
algorithm. By leveraging multiple data sources and evaluating hundreds
of variables, we've been able to successfully distinguish high-risk
customers from low-risk customers and price accordingly. As a result of
this innovation, our average interest rates are 50 percent lower than
other leading online lenders and almost 75 percent lower than a typical
payday loan product. Furthermore, because we use the simple daily
interest method, customers can save money by making early payments when
they have extra funds. In fact, roughly one-third of our customers
choose to pay off their loans early.
Over the past 2 years, we've been working hard to foster
relationships with the major credit bureaus and have dedicated
significant resources to building the technology necessary to report
performance data. We are very excited to help our customers build
credit history in order to achieve a brighter financial future.
Now that I've told you about one example of how Enova is innovating
and the benefits we can offer our customers, let me tell you about the
significant challenges we face due to the current regulatory landscape.
It is our belief that the current State laws do not adequately serve
consumers. Instead of working toward innovative solutions that can be
scaled across 50 States, we are forced to develop new products for
individual States within the constraints of antiquated consumer credit
statutes that were not drafted for current technologies or Internet
lending. In many cases, instead of allowing customers a choice of
quality credit options, current State law forces borrowers into single
payment loans.
Our mission at Enova is to create high-quality, innovative products
that can not only serve an immediate credit need, but can also help
consumers achieve a better financial future. We have proactively shared
our experience with groups like Center for Financial Services
Innovation and the CFPB's Project Catalyst in an effort to promote
policies that will help working families throughout the country achieve
equal access to quality credit. We envision uniform Federal standards
that enable innovation to meet the needs of today's increasingly
mobile, tech-savvy consumers.
I encourage you to support legislation to modernize our laws. Thank
you, Chairman Brown and Committee Members, for permitting me to present
this testimony. I would be happy to answer any questions you may have.
______
PREPARED STATEMENT OF NICK BOURKE
Director, Safe Small-Dollar Loans Research Project, The Pew Charitable
Trusts
March 26, 2014
Chairman Brown, Ranking Member Toomey, and Members of the
Subcommittee, thank you for the opportunity to join in your discussion
about alternative financial services. My commentary will focus mainly
on small-dollar loans, including payday and installment loans. Also
included below are observations based on Pew's latest research about
general-purpose reloadable prepaid debit cards.
As the director of the small-dollar loans project at The Pew
Charitable Trusts, \1\ I appreciate the opportunity to engage with you
on these important consumer finance issues. The following comments are
informed by in-depth research that Pew has conducted over the past 3
years. This research includes nationwide telephone surveys
(representative of all payday loan borrowers, \2\ and all prepaid card
users), more than a dozen focus groups with consumers across the
country, a case study of Colorado's legislative decision to replace the
conventional 2-week single-repayment payday loan with a 6-month
installment loan, and other analysis.
---------------------------------------------------------------------------
\1\ The Pew Charitable Trusts is a nonprofit, research-based
organization. Our work includes providing research and analysis to help
ensure a safe and transparent marketplace for consumer financial
services. We conduct research that identifies the needs, perceptions,
and motivations of those who use payday and similar loan products, as
well as the impact of market practices and potential regulations.
\2\ Pew's telephone survey followed the highest methodological
standards, including random digit dialing (RDD) to fixed-line and
mobile phones in every State, a minimum of six attempts per phone
number, and inclusion of Spanish speakers. The survey initially
screened 49,684 respondents to identify a sufficient number of people
who had reported using a payday loan (both storefront and online
cohorts were established). Depending on the question, between 451 and
703 payday loan borrowers completed the in-depth opinion survey. The
margin of error for usage and demographic data from the survey is 0.2
percentage points. For the in-depth opinion research, the margin of
error is between 4.2 and 4.6 percentage points, depending on the
question.
---------------------------------------------------------------------------
I. Small-Dollar Loans (Payday and Installment Loans)
Pew has published three full-length reports in our Payday Lending
in America series, as well as various summaries, all available at
www.pewtrusts.org/small-loans. Data discussed throughout these comments
are based on Pew's research as well as analysis of industry and
regulatory data, unless otherwise noted. For your convenience, I have
appended to these comments a two-page summary of key findings from our
payday and small-dollar loan research, and a copy of Pew's policy
recommendations for reform in this market.
Background: Payday Loans and the Financially Fragile, ``Thick-File''
Consumers Who Use Them
Thirty-five States allow conventional payday loans, and
approximately 12 million Americans use payday loans annually. These are
loans usually due in full on the borrower's next payday and secured by
a postdated check or authorization to debit a checking account. The
loans average $375, have a term of about 2 weeks, and carry an average
fee of about $55 per pay period. The median borrower keeps a loan out
for 5 months of the year and spends $520 on finance charges to
repeatedly borrow the same $375 in credit.
Most payday borrowers (69 percent) in Pew's national survey
reported that they turned to the loan to get money to pay ordinary
living expenses, including rent, utilities, and credit card bills. Only
16 percent of borrowers used the loans for an unexpected expense, like
a car repair or medical emergency.
The research paints a vivid picture of ongoing financial struggle.
Six out of ten borrowers report that they have trouble paying bills at
least half the time, with one quarter of all borrowers reporting that
it is difficult to pay bills every month. Such persistent difficulty
often leads to desperation. Thirty-seven percent of payday borrowers
say that they have been in such a difficult situation that they would
take any payday loan, on any terms offered. People who are facing such
dire financial circumstances report feeling grateful to receive payday
loans, which usually require little paperwork. Yet most also say that
the loans take advantage of them.
While it is true that payday loan borrowers have few credit options
available to them, it is not because they lack access to the mainstream
credit market. Rather than being ``thin-file'' or ``no-file'' consumers
who are creditworthy but unable to find lenders willing to do business
with them, most payday loan borrowers are ``thick-file'' consumers who
have substantial (negative) experience with debt. In other words,
payday borrowers are not trying to get into the mainstream credit
system; they are failing out of it.
Typical payday loan applicants have poor credit scores in the low
500s, \3\ indicating an assessment by credit reporting agencies that
they are already overburdened with debt and/or struggling to meet
financial obligations. More than half of payday loan applicants carry
credit card debt, two in five payday borrowers own homes (many with
mortgages), and many also hold other debt. Most payday borrowers also
pay overdraft fees, and this fact is a reminder that payday loans do
not eliminate the risk of overdrafting. \4\
---------------------------------------------------------------------------
\3\ Neil Bhutta, Paige Marta Skiba, and Jeremy Tobacman, ``Payday
Loan Choices and Consequences'', Vanderbilt Law and Economics Research
Paper, no. 12-30 (2012), http://papers.ssrn.com/sol3/
papers.cfm?abstract_id=2160947.
\4\ Pew's survey shows that most payday borrowers have overdrafted
in the past year. See also Consumer Financial Protection Bureau,
``Payday Loans and Deposit Advance Products: A White Paper of Initial
Data Findings'' (2013), http:// files.consumerfinance.gov/f/
201304_cfpb_payday-dap-whitepaper.pdf.
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Loan Payments Average One-Third of a Borrower's Next Paycheck--An
Unaffordable Burden
When a payday borrower gets a loan, he or she usually uses it to
help pay rent, utilities, or other bills. The loan temporarily solves
these problems. However, on the borrower's next payday, the full amount
of the loan--plus the fee--is due. For an average storefront loan, the
amount due on payday is $430. For someone who makes $31,000 per year,
the median payday borrower's income nationwide, $430 represents 36
percent of his or her bi-weekly income, before taxes. By contrast,
Pew's research has found that most borrowers cannot afford to pay more
than 5 percent of their pretax paycheck toward a loan payment while
still meeting their other financial obligations.
Sacrificing one-third of their paycheck to repay a payday loan
makes it harder for borrowers to pay their regular bills. Consequently,
most renew or quickly reborrow a loan to make ends meet, with many
retiring their debt only after a cash infusion, like a tax refund or
assistance from family or friends, to repay the loan. While the loans
are marketed as short-term fixes, they are usually experienced as long-
term burdens. The average borrower carries payday loan debt for five
months of the year, and most borrowing is consecutive (three-quarters
of all payday loans originate within one pay period of a previous
loan).
Lenders' profitability relies on this repeated usage. Industry
analysts estimate that customers do not become profitable to payday
lenders until they have borrowed four or five times. \5\ Researchers at
the Kansas City Federal Reserve found that ``the profitability of
payday lenders depends on repeat borrowing,'' \6\ a sharp contrast to
official statements from the industry that payday loans are not meant
as a long-term solution. \7\ In Pew's analysis, lenders' reliance on
long-term borrowing behavior indicates a fundamental flaw in the
business model that can only be addressed by requiring loans to be
structured differently (mainly, as installment loans).
---------------------------------------------------------------------------
\5\ David Burtzlaff and Brittny Groce, ``Payday Loan Industry''
(Stephens Inc., 2011), 15.
\6\ Robert DeYoung and Ronnie J. Phillips, ``Payday Loan
Pricing'', (Federal Reserve Bank of Kansas City, Economic Research
Department, February 2009), 7, http://www.kansascityfed.org/PUBLICAT/
RESWKPAP/PDF/rwp09-07.pdf.
\7\ Community Financial Services Association of America, ``Is a
Payday Advance Appropriate for You?'' accessed Sept. 20, 2013, http://
cfsaa.com/what-is-a-payday-advance/is-a-payday-advance-appropriate-for-
you.aspx.
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The required lump-sum payment far exceeds the borrower's ability to
repay, yet lenders maintain profitability by relying on some unique
benefits granted to them by State laws. Payday lenders have the legal
power to withdraw payment directly from borrowers' checking accounts on
their next payday, prompting those without enough money left for rent
or other bills to repay the loans and quickly reborrow, effectively
paying an interest-only fee to reset the due date to the next payday.
This extraordinary form of loan collateral, which is achieved through
use of postdated checks or electronic access to borrowers' checking
accounts, acts as a ``super lien'' against the borrower's income stream
that allows lenders to thrive even as they make loans to those who
cannot afford them. This power to capture borrower income enables
lenders to make small-dollar loans without underwriting them to ensure
that the borrower can both repay the loan and meet other financial
obligations without having to borrower again to make ends meet.
The Lump-Sum Payday Loan Is a Failed Product
Policy discussion in recent years has focused on whether payday
loan customers need more access to credit, and what rate of interest is
appropriate for such loans. These are valid questions, but there is
insufficient evidence to know whether consumers are better off with or
without access to high-interest loans (even if the loans have
affordable payments).
There is, however, sufficient evidence to conclude that
conventional lump-sum payday loans harm consumers compared with loans
that have affordable payments. It is clear that the lump-sum payday
loan has inherent structural flaws that make it unaffordable and
dangerous for consumers, and that new policies to eliminate this
harmful product are warranted. Pew's research and analysis show that
clearly, and just this week the Consumer Financial Protection Bureau
(CFPB) released a new white paper \8\ with yet more proof that the
lump-sum payday loan is a failed product. The CFPB's analysis of
millions of payday loan records vividly demonstrates that the payday
loan is not the short-term product that it claims to be, and that
costly, long-term borrowing is the rule and not the exception. The
report also shows that anything short of fundamentally reforming how
small-dollar loans are structured would be an inadequate policy
response to these problems. Overall, the CFPB's latest report sets a
high bar for what the policy solution needs to be, and it leaves little
doubt that the CFPB should require an ability to repay standard for the
small-dollar loan market. Pew's research shows that such reform would
eliminate the worst problems in this marketplace without significantly
impacting access to credit.
---------------------------------------------------------------------------
\8\ The Consumer Financial Protection Bureau, ``CFPB Data Point:
Payday Lending'' (2014), http://files.consumerfinance.gov/f/
201403_cfpb_report_payday-lending.pdf.
---------------------------------------------------------------------------
Pew's Policy Recommendations for the Small-Dollar Loan Market (Payday
and Installment Loans)
Pew has called on policy makers to act urgently, and take one of
two approaches to addressing this problem. Policy makers can choose to
prohibit high-cost payday loans altogether (as 15 States have done), or
permit them only with substantial structural reforms to ensure the
loans have affordable payments and follow a few sensible safeguards to
ensure a safe and transparent marketplace.
To support the CFPB and other policy makers, Pew has proposed five
regulations for reforming payday loans. These rules will minimize harm
to consumers and make all small-dollar loans more affordable. To ensure
an effective and simplified regulatory environment for all lenders,
these recommendations are intended to apply to all small-dollar loans,
including payday and installment loans, with the exception of pawn
loans. What follows is a summary (detailed recommendations are
attached).
1. Limit payments to an affordable percentage of a borrower's
income. Monthly payments above 5 percent of monthly pretax
income are unaffordable for most borrowers. Loans requiring
more should be prohibited unless rigorous underwriting shows
that the borrower can repay the loan while meeting other
financial obligations.
This recommendation is intended to provide a clear yet flexible
ability-to-repay standard, one that may accommodate lenders by
providing for a low-cost and streamlined underwriting process
while requiring most loans to be restructured as affordable
installment loans (as opposed to unaffordable lump-sum
repayment loans). Such a standard is flexible, easily
accommodating various levels of income, pricing, and loan size.
2. Spread costs evenly over the life of the loan. Front-loading of
fees and interest should be prohibited. Any fees should be
spread evenly over the life of the loan, and loans should have
substantially equal payments that amortize smoothly to a zero
balance.
This recommendation addresses a common problem found in
installment loan markets intended to serve those with damaged
credit histories. When origination fees or other front-loaded
charges make the first month of a loan substantially more
profitable for the lender than subsequent months, lenders have
an incentive to encourage borrowers to refinance loans. When
loans are frequently refinanced, borrower costs increase
dramatically, lenders can mask defaults by inviting struggling
borrowers to skip a periodic payment in exchange for forfeiting
previously repaid principal, and the overall length of
indebtedness can extend indefinitely.
3. Guard against harmful repayment or collections practices. Policy
makers should prevent or limit the use of postdated checks and
automatic withdrawals from borrowers' bank accounts. They
should also make it easier to cancel automatic electronic
withdrawals and protect against excessively long loan terms.
This recommendation is focused on protecting borrower checking
accounts by ensuring that borrowers have the power to stop
payments or close accounts to avoid unscrupulous or fraudulent
lenders. It also recognizes that some small-dollar loans could
have affordable periodic payments yet require repayment terms
that last an unconscionably long time unless policy makers
require shorter terms or ensure that each periodic payment
includes a substantial principal reduction.
4. Require concise disclosures of periodic and total costs. Loan
offers should clearly disclose, with equal weighting: the
periodic payment schedule, the total repayment amount, the
total finance charge, and the effective annual percentage rate
(APR) inclusive of all fees.
To make good decisions, borrowers need clear and reliable
information.
5. Continue to set maximum allowable charges. Almost every State
sets maximum allowable rates on some small-dollar loans because
these markets serving those with poor credit histories are not
price competitive. Policy makers may limit rates to 36 percent
or less if they do not want payday lenders to operate, or
somewhat higher if they do.
Research Shows Safeguards Can Work: A Case Study From Colorado
In 2010, Colorado lawmakers agreed that the State's 18-year
experiment with conventional payday lending had led to unintended and
harmful consequences. They dramatically changed the State's payday loan
law, shifting from allowing lump-sum repayment loans due in full on the
borrower's next payday to requiring that borrowers be allowed at least
6 months to repay the loans. This major change provided a research
opportunity to study the small-dollar loan market and its impact on
borrowers before and after the law change. Pew's report, Payday Lending
in America: Policy Solutions (2013), discusses the Colorado case study
in detail.
Colorado's experience with their new payday loan law demonstrates
that reforms such as those listed in Pew's policy recommendations are
viable for both borrowers and lenders. There are at least eight clear
benefits of Colorado's structural payday loan reform:
1. Borrowers maintained access to credit;
2. Lenders are still in business (half of stores still open in
locations throughout the State);
3. Loan payments are more affordable (4 percent of paycheck now vs.
38 percent before);
4. The average borrower spends less ($277 now vs. $476 before);
5. Lender-charged bounced check fees are down 57 percent;
6. Defaults per year have declined 30 percent;
7. Making the loan safer and more affordable reduced the amount of
oversight required to ensure consumer safety;
8. Credit counselors and elected officials report fewer people
coming to them with payday loan problems.
Payday Borrowers Want Policy Makers To Act
On a final note regarding small-dollar loans, borrowers
overwhelmingly want policy makers to act. Pew's nationally
representative survey shows that, by a 3-to-1 margin, payday loan
borrowers want more regulation of this market. Most borrowers favor
requirements that would restructure payday loans into installment loans
with more affordable payments. For example, eight in ten favor a
requirement that loan payments take up only a small amount of each
paycheck. \9\
---------------------------------------------------------------------------
\9\ The Pew Charitable Trusts, ``Payday Lending in America: Policy
Solutions'' (2013), 22, http://www.pewstates.org/research/reports/
payday-lending-in-america-policy-solutions-85899513326.
---------------------------------------------------------------------------
II. Prepaid Debit Cards and Why Some Consumers Are Turning Away From
Banks
The following section highlights findings from recent Pew research
about general-purpose reloadable (GPR) prepaid debit cards. GPR prepaid
cards act like checkless checking accounts and are available from a
wide range of companies, including many nonbank, alternative financial
services providers as well as an increasing number of bank providers.
Millions of Americans are turning away from banks for some or all
of their financial needs, because nonbank products are providing
something most banks are not. A key finding from Pew's consumer
research in the prepaid card market is that for many consumers, what
they are seeking is better control over their finances--including
safety from overdraft fees and security against overspending and the
temptations of credit. Attempts to serve these consumers will be more
successful if they are designed to help achieve these goals, and
regulators should help ensure that consumers can successfully achieve
the control and security that they seek. As explained further below,
Pew's research has led us to conclude that GPR prepaid cards should not
have overdraft or other automated or linked credit features, and that
the CFPB should prohibit such features.
There Is a Large and Apparently Growing Group of Consumers Who Have
Used the Banking System But Are Going Outside of It for Some or
All of Their Financial Services Needs
Nationwide, 88 percent of GPR prepaid card users either have or
used to have a checking account (59 percent of all prepaid users
currently have a checking account). In other words, the vast majority
of people who use prepaid cards have experience with bank accounts but
have opted to go outside the banking system for some or all of their
financial services. \10\ (The prepaid card market is growing rapidly; a
short summary of who uses prepaid cards is attached at the end of this
comment letter.)
---------------------------------------------------------------------------
\10\ The Pew Charitable Trusts, ``Why Americans Use Prepaid
Cards'' (2014), 7.
---------------------------------------------------------------------------
The Desire To Gain Control Over One's Finances--and Avoid Overdraft and
the Temptations of Credit--Is Leading Millions To Seek Services
Outside the Banking System
The fact that so many prepaid card users have or used to have bank
accounts raises an important question: Why are so many people looking
for financial services outside the banking system? Pew's nationally
representative survey data show clearly that prepaid card users are
trying to regain control of their financial lives, chiefly by avoiding
debt; not spending more money than they have; avoiding overdraft fee;
and insulating themselves from the temptations of credit .
---------------------------------------------------------------------------
\11\ Ibid., 14.
And the reason that consumers are turning to prepaid cards to find
this control is also clear: prepaid cards on the market today generally
do not let consumers spend more money than they load onto the cards in
the first place. In Pew's analysis, only eight percent of prepaid cards
from the major national providers disclose an overdraft feature. The
vast majority of cards explicitly disclose that overdraft is not
possible (80 percent). \12\
---------------------------------------------------------------------------
\12\ The Pew Charitable Trusts, ``Consumers Continue To Load Up on
Prepaid Cards'' (2014), 9-10, www.pewtrusts.org/prepaid.
---------------------------------------------------------------------------
Compare that to the checking accounts offered by the Nation's banks
and credit unions, where overdraft penalty fees are ubiquitous, median
charges are $25 per overdraft for credit unions or $35 for banks, and
customers can typically be charged four such fees per day. \13\
---------------------------------------------------------------------------
\13\ The Pew Charitable Trusts, ``Checks and Balances: Measuring
Checking Accounts' Safety and Transparency'' (2013), http://
www.pewstates.org/research/reports/checks-and-balances-85899479785.
---------------------------------------------------------------------------
A 2012 Pew survey showed that a strong majority of checking account
holders nationwide feel that such overdraft programs are more harmful
than helpful, and 75 percent of checking account customers said they
would rather have a transaction declined than incur a $35 overdraft
fee. New opt-in disclosures mandated in 2010 by the Federal Reserve
have not resolved this situation: More than half of those who
overdrafted since that time did not believe that they had opted in.
\14\
---------------------------------------------------------------------------
\14\ The Pew Charitable Trusts, ``Overdraft America: Confusion and
Concerns About Bank Practices'' (2012), www.pewstates.org/
uploadedFiles/PCS_Assets/2012/SC-IB-Overdraft%20America(1).pdf.
---------------------------------------------------------------------------
Together, these findings show that when consumers choose prepaid
cards, they are often seeking--and are generally finding--shelter from
the risk of overdraft and overspending. Unfortunately, these benefits
of prepaid cards may not last. Prepaid card providers typically retain
the contractual right to change terms at any time for any reason, and
there is little or no regulatory protection against overdraft or linked
lines of credit. The CFPB should prevent overdraft and linked or
automated lines of credit from proliferating in this market as a way of
preserving the ``prepaid'' nature of the product and helping preserve
the control mechanism that has drawn consumers to adopt it. \15\
---------------------------------------------------------------------------
\15\ For Pew's policy recommendations, see The Pew Charitable
Trusts, ``Consumers Continue To Load Up on Prepaid Cards'' (2014),
www.pewtrusts.org/prepaid.
---------------------------------------------------------------------------
Prepaid Card Users Do Not Want the Product To Have Overdraft or Linked
Credit
Prepaid users want their cards to remain free of overdraft and
automated or linked credit features. One driver of this sentiment is
past experience. As noted above, the vast majority of prepaid card
users have or used to have a bank account. Of these, 41 percent have
closed or lost a checking account because of overdraft fees. \16\ Thus,
it is not surprising that 63 percent of prepaid users cite ``avoiding
overdraft fees'' as a reason for using the card, with similar
majorities saying they use the card for ``avoiding credit card debt,''
and ``helping you not spend more money than you actually have.'' \17\
---------------------------------------------------------------------------
\16\ The Pew Charitable Trusts, ``Why Americans Use Prepaid
Cards'' (2014), 8.
\17\ Ibid, 14.
---------------------------------------------------------------------------
Prepaid card users view mechanisms that would allow them to spend
more money than they have as self-defeating. They find credit options
tempting, and got a prepaid card to help them avoid the risk of
overspending and overdraft fees. Altogether, 71 percent of prepaid
users say they would not like to have the ability to overdraft their
card balance for a fee, with 69 percent rejecting linked payday loans
and 63 percent rejecting linked lines of credit. As one prepaid card
user said in a Pew focus group, with credit features ``it will turn
into a credit card, and it will not be a prepaid card anymore. It will
lose its meaning.'' \18\
---------------------------------------------------------------------------
\18\ Ibid., 21.
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Lessons From Prepaid
The case of prepaid cards demonstrates that there is a large and
rapidly growing market for nonbank transaction accounts. Most prepaid
cards offer the functionality of a checking account (direct deposit,
ATM access, and in most cases electronic bill pay) \19\ with one key
distinction: no overdraft or ability to spend more than they have
deposited. The fact that the majority of prepaid users also have a
checking account strongly suggests that they are looking for services
or features that banks are not providing. The strength of consumer
opinion in favor of more control, and against overdraft and
overspending, tells us what many consumers are looking for when they go
outside the bank system. Yet bank checking accounts continue to place
overdraft as a core product feature.
---------------------------------------------------------------------------
\19\ Though prepaid cards generally have a version of deposit
insurance and liability limits for unauthorized transactions, they are
generally inferior to those on bank checking accounts--something policy
makers should address. The Pew Charitable Trusts, ``Consumers Continue
To Load Up on Prepaid Cards'' (2014).
---------------------------------------------------------------------------
Looking forward, efforts to increase access to beneficial banking
services must take these findings into account. Efforts that help
consumers meet the goal of avoiding overdrafting and overspending will
be more likely to succeed; efforts that do not take this goal into
account or put consumers at risk will be more likely to fail. In May of
2012, the CFPB issued an Advance Notice of Proposed Rulemaking for the
prepaid card market. In the announcement, CFPB director Richard Cordray
noted that, while prepaid cards serve some of the most vulnerable among
us, the cards also have far fewer regulatory protections than bank
accounts or debit or credit cards. \20\ When the CFPB takes the next
step of proposing actual rules, it should ensure that overdraft and
automated or linked lines of credit are firmly prohibited and do not
spread into the prepaid card market.
---------------------------------------------------------------------------
\20\ http://www.consumerfinance.gov/newsroom/consumer-financial-
protection-bureau-considers-rules-on-prepaid-cards/
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In conclusion, I would like to thank you for allowing Pew to take
part in this discussion. We especially hope that Congress will use its
influence to help the Consumer Financial Protection Bureau to achieve
its mission of enacting a strong, broad, fair, and principles-based
regulatory policy for the small-dollar loan market. A summary of Pew's
recommendations for small-dollar loan rules is attached and detailed
information is available at www.pewtrusts.org/small-loans. My
colleagues at The Pew Charitable Trusts and I would welcome the
opportunity for further conversations at any time.
PREPARED STATEMENT OF DAVID ROTHSTEIN
Director, Resource Development and Public Affairs, Neighborhood Housing
Services of Greater Cleveland
March 26, 2014
Senator Brown and Ranking Member Toomey, my name is David
Rothstein, director of public affairs for Neighborhood Housing Services
of Greater Cleveland and research fellow in the asset building program
with the New America Foundation. I appreciate the opportunity to
testify before you today regarding small dollar lending, most commonly
referred to as payday lending. For more than 10 years I have researched
small dollar lending and financial services to low-income families.
Outlined in this testimony I hope to convey the importance of
strong regulation around small dollar lending, particularly from the
Federal Government, as local authorities wrestle to ensure consumers
receive safe and affordable loan products. It is imperative that we
look at the characteristics of the loan such as the APR interest rate
and method of payback to assess the quality of the product.
First, the traditional payday loan model in Ohio and alive in
dozens of other States does not serve families well. Research of actual
borrowers continues tell this story in numerous ways--the latest Pew
Charitable Trust Research and day old report by the CFPB providing the
most startling research to date. I say that it doesn't serve them well
because the average family takes out 8 to 12 loans per year from one
lender, typically purchasing loans in back-to-back transactions. This
is absolutely the typical Ohio customer. This means as soon as their
loan is repaid, they immediately reborrow to cover other expenses. This
is also the prototypical debt cycle. Our housing and financial
capabilities counselors indicate that most clients have loans from
about four different stores. Keep in mind that many families cannot
afford to pay back the principle balance of the loan in just two weeks
let alone interest and principle. If payback does occur, other monthly
budget items suffer such as rent, utilities, food, and car payments.
Second, payday lenders in Ohio morphed into auto title and
installment lenders. This is also quite typical. And also more
expensive. Ohio's battle to reform and better regulate payday lending
continues marking an almost 8 year conflict. In 2008, the Ohio General
Assembly passed a bipartisan bill to curtail the interest rate, loan
amount, and number of loans per year in Ohio. The law requires lenders
to not sell more than four loans per person per year and not more than
28 percent APR interest. The reduction is significant since lenders
charge 391 percent APR interest. The day after Governor Strickland
signed the legislation, payday lenders and their trade association
announced that they would go to the ballot, to the voter, and try to
reverse the law. Despite spending at minimum $10 million, they suffered
a wide-margined defeat with voters. Yet, not a single payday lender in
Ohio uses the law (Small Loan Act) but rather two antiquated mortgage
lending laws to sell loans at essentially the same price, if not more,
than before.
Most recently, lending in Ohio expanded to include selling high
cost loans using automobile titles as collateral. An auto title loan is
more dangerous than a payday loan in the sense that people can and do
lose their car once they are too far into debt. I have included a 3-
part story from the Akron Beacon Journal about a working mother of
three who lost her car and nearly her home after this loan. Installment
loans, the newest payday product, offered by payday lenders carry a
similar triple-digit interest rate and use the Credit Service
Organization law to sell loans for up to 12 months. One loan that I
analyzed cost a borrower $5,000 to borrow $2,000 over a 12-month
period.
Finally, At NHS of Greater Cleveland, we practice what we preach.
Since we advocate smart home ownership, we purchased our building in
the recovering area of Slavic Village. Since we are notably critical of
payday lending, we are developing two alternatives. Working with the
innovative start-up company Employee Loan Solutions, we will be working
with large employers to provide access to safe, underwritten, low-cost
loans through their paycheck. The lender is a CDFI focused on providing
low-income families with affordable financial products. The other
program is a small dollar loan serviced and managed by NHS of Greater
Cleveland. The intent is to comply with Ohio's payday lending law, the
only group in Ohio to do so.
As this Congress and the Consumer Financial Protection Bureau
consider rules and regulations around small dollar lending, a floor on
small dollar loans will encourage high-quality innovation.
Lenders should be required to fully assess a borrower's ability to
repay a loan, in full and on time, without the use of repeatedly
cashing a check or electronically debiting an account. Just like
mortgages or credit cards, ability to repay requirements protect
borrowers from unsustainable debt. But when lenders have the ability to
collect payments using postdated checks or electronic transfers, they
know they will get paid even if it causes financial hardship or forces
a borrower to take out another loan to pay off the first. Lenders
should not be able to use postdated checks and electronic payments to
access a borrower's bank account if they are unable to repay a loan.
The litmus test is that automatic payment should be a convenience for
the borrower not a side-step to debt collection laws.
I appreciate your time and commitment to ensuring that low- and
moderate-income families are best served in the financial sector. I am
happy to answer any questions that you may have.
PREPARED STATEMENT OF NATHALIE MARTIN
Frederick M. Hart Chair in Consumer and Clinical Law, University of New
Mexico School of Law
March 26, 2014
Thank you, Chairman and Members of the Subcommittee for the
opportunity to provide this written testimony in connection with the
hearing entitled ``Are Alternative Financial Products Serving
Consumers?'' Below I provide a background of my credentials, describe
some of my research on high-cost credit, describe the different forms
of high-cost credit, and then explain why I believe that enacting a
Federal usury cap is the simplest and most effective way to regulate
these forms of credit.
I. Background
My Credentials and Research
I am the Frederick M. Hart Chair in Consumer and Clinical Law
University of New Mexico School of Law. This endowed chair is thought
to be the only one in the U.S. dedicated to consumer law issues.
Although I write in other areas as well, the primary focus of my
research is high-cost loan products (which include payday loans, title
loans, and triple and quadruple-digit interest rate installment loans),
and public attitudes about these forms of credit.
My research on high-cost lending includes the articles listed
below, which can be found at http://papers.ssrn.com/sol3/cf_dev/
AbsByAuth.cfm?per_id=1313797.
``Interest Rate Caps, State Legislation, and Public Opinion: Does the
law Reflect the Public's Desires?'' 89 Chicago Kent L. Rev. 1
(2013) (with Timothy Goldsmith).
``High-Interest Loans and Class: Do Payday and Title Loans Really Serve
the Middle Classes?'', 24 Loyola Consumer L. Rev. 524 (2012) (with
Ernesto Longa).
``The Alliance Between Payday Lenders and Tribes: Are Both Tribal
Sovereignty and Consumer Protection at Risk?'', 69 Wash & Lee L.
Rev. 751 (2012) (with Joshua Schwartz).
``Grand Theft Auto Loans: Repossession and Demographic Realities in
Title Lending'', 77 Missouri Law Rev. 41 (2012) (with Ozymandias
Adams).
``Regulating Payday Loans: Why This Should Make the CFPB'S Short
List'', 2 Harv. Bus. L. Rev. Online 44 (2011), available at: http:/
/www.hblr.org/?p=1595.
``1,000 Percent Interest--Good While Supplies Last: A Study of Payday
Loan Practices and Solutions'', 52 Arizona Law Review 563 (2010).
``Double Down-and-Out: The Connection Between Payday Loans and
Bankruptcy'', 39 Southwestern L. Rev. 789 (2010) (with Koo Im
Tong).
My Research Progression and Empirical Findings
I have done five empirical studies related to high-cost lending and
attitudes toward high-cost lending.
First Study in 2009
I devised my first study, ``1,000 Percent Interest--Good While
Supplies Last: A Study of Payday Loan Practices and Solutions'', after
meeting clients in our clinical law program that had taken out the
loans. Before meeting these clients, I had no idea what the terms of
these loans actually were. Once I saw the 1,000 percent interest rates,
I had to learn more. As a person who believes markets can serve people
and respond to competition and consumer complaints, I wanted to find
out why the rates never seemed to drop even when more lenders entered
the market. I also wanted to find out what people were using the loans
for and whether consumers shopped based upon the rates. Finally, I
wanted to determine if consumers knew the loans were interest-only
loans when they took them out. I went into the study with an open mind,
just trying to learn the facts. In the study, published in the Arizona
Law Review, I and my students interviewed 109 consumers outside payday
lending stores. Key findings of this study include:
People Do Not Shop for Payday Loans on the Price So the Market Does Not
Reduce Cost
People do not shop for price when obtaining a payday loan but
instead take out loans near home or work out of convenience, or go to
lenders that friends or family members have used. This means that the
market forces that would usually reduce prices through competition do
not work. Indeed, regardless of how many new lenders enter the market,
prices only go up, never down.
Most Customers Do Not Understand the Loans Before They Get Into Them
People have difficulty understanding the terms of the loans and are
very surprised when they go in and make a payment of $80 on a $400 loan
and the $80 payment does not reduce the principle on the loan at all.
People also cannot calculate the annual percentage rate on the loan
(for example, by multiplying the 14 day rate by 26 periods of 14 days
within a year), and thus cannot easily compare the cost of this credit
to other forms of credit.
Some people thought that a rate of $15 per $100 borrowed for 14
days (390 percent per annum) was less expensive than a credit card rate
of 25 percent per annum. One woman was proud of herself for using these
loans instead of student loans.
Customers' Use of the Loans
People do not use the loans for short term needs. Many people who
use these are in continuous debt, often with more than one loan.
Many people reported having low cost or no cost options to taking
out the loan, including doing without or asking a friend or family
member. Getting the high-cost loan just seemed easier, until they saw
how hard it was to pay back.
People generally are not able to pay the loans back as quickly as
they thought they would.
People use the loans primarily for regular monthly expenses, not
emergencies, which means these consumers are worse off the following
month than they were before they took out the loan. They now have
another monthly bill to pay.
Subsequent Empirical Research
Before I began the first study, I had no idea how many loans
consumers carried at a time. I assumed most people used just one loan
at a time. Discovering the use of multiple loans at a time led to my
next study, an empirical analysis of the debts of over 1,000 bankruptcy
debtors to determine what percentage of the debtors used payday loans
in a State with lax regulations, and of those, how many loans the
borrowers had. I discovered that 19 percent of debtors in the study
used the loans, that nearly 70 percent of those with loans had more
than one, that 37 percent had more than 5 loans, and that an astounding
14 percent had more than 10 loans. \1\
---------------------------------------------------------------------------
\1\ ``Double Down-and-Out: The Connection Between Payday Loans and
Bankruptcy'', 39 Southwestern L. Rev. 789 (2010) (with Koo Im Tong).
---------------------------------------------------------------------------
In my next study, I analyzed State data on title loans and
discovered, among other things that title lenders do not underwrite the
loans for affordability and that the loans create a high risk of
repossession. \2\ I then did a demographic study of borrowers, again
using bankruptcy data, and discovered that most payday loan borrowers
are not middle class people as the industry suggests but that these
borrowers typically have lower incomes than the median income in their
State and also have lower home ownership rates than the average. \3\
These results have been recreated in numerous studies, including ``Do
Payday Loans Really Serve the American Middle Class? An Empirical
Analysis'', in a recent issue of the Journal of Consumer Affairs.
---------------------------------------------------------------------------
\2\ ``Grand Theft Auto Loans: Repossession and Demographic
Realities in Title Lending'', 77 Missouri Law Rev. 41 (2012) (with
Ozymandias Adams ).
\3\ ``High-Interest Loans and Class: Do Payday and Title Loans
Really Serve the Middle Classes'', 24 Loyola Consumer L. Rev. 524
(2012) (with Ernesto Longa).
---------------------------------------------------------------------------
II. Background of Topic: Terms of Various Types of High-Cost Loans
There are many varieties of high-cost loans, a few of which are
described here as background.
Payday Loans
A true ``payday'' loan is called a payday loan because its original
purpose was to help a customer survive a short-term cash flow crisis
between the time of the loan and the customer's next payday. In one
common form of payday loan, a consumer borrows money at a rate of
between $15 and $25 per $100 for a period of 14 days or less. In other
words, if a consumer was paid 4 days ago but is already out of cash,
she can go borrow, for example, $400 between now and her next payday
(now 10 days away). To get that $400 at the $15 per $100 rate she would
need a checking account and would write a check, or authorize an
automatic debit, for $460 postdated to her next payday.
When payday comes, she can either let the check or debit clear,
assuming the unlikely event that she now has this money, or she can go
in and pay another $60 to borrow the same $400 for the next 2 weeks.
When taken as an annual percentage rate, calculated by multiplying this
rate by twenty-six 2-week periods over the course of a year, these
terms result in an interest rate of 390 percent per annum or higher.
Typical State payday loan laws (in States that have them) limit
interest and fees to $15 per $100 (390 percent or more) but only if the
loan is 14-35 days in duration. These laws do not apply to longer
loans.
Title Loans
Another type of high-cost loan is the auto title loan, for which
consumers do not need bank accounts. Rather borrowers simply need an
unencumbered automobile to secure the loan. These loans carry a typical
interest rate of 25 percent per month or 300 percent per annum. While
title loans typically carry lower interest rates than payday loans,
they tend to be larger loans, increasing the chances that they will be
difficult to repay and will create a debt trap. They also subject
borrowers to the possibility of losing their vehicle, a risk not
encountered with the other forms of high-cost loans.
Installment Loans
Yet another type of high-cost loan is the so called ``installment
loan.'' This is the new loan of choice for many lenders as these loans
allow lenders to skirt State laws regulating loans made for 14 to 35
days.
The phenomenon of morphing loans into another form in order to
avoid State laws is discussed in more detail below, but in short,
lenders make installment loans to avoid State payday loan laws, simply
by making loans with durations longer than 35 days. Longer loans fall
outside the regulations and thus remain unregulated. In one such
installment loan, a customer borrowed $100, to be repaid in twenty-six
bi-weekly installments of $40.16 each, plus a final installment of
$55.34. In total, this borrower paid a total of $1,099.71 on a $100
loan. The annual percentage rate on the loan was 1,147 percent.
III. Solutions to the Problems Caused by High-Cost Loans
There are many ways to legislate high-cost credit, but most methods
that have been tried have failed. One method that has not failed is
simply capping interest rates. Other possible solutions may exist, but
each has its problems. For example, a law could be passed that would
require that lender underwrite their loans. Lenders would need to
ensure that borrowers could afford to make their regular monthly
expenses and also pay back the loan. Otherwise, the loan could not be
made. If the loan was made anyway, it would not be enforceable.
Another middle ground would be forbidding rollovers or back to back
loans from the same lender or different lenders, and limiting the
number of loans a consumer could take out in a given time frame. This
could be enforced through a national database in which all loans would
need to be placed. A well written law would provide that if a loan did
not appear in the database, it would not be enforceable and the lender
could not take any action to collect it.
Lenders dislike these options, claiming that the latter violates
consumer privacy rights and that the former, the underwriting, is too
complex. I agree that these options are complex. I also fear that
lenders would find ways around compliance, similar to the loopholes
they have used in the past. Because of these potential loopholes and
also these complexities, I prefer a far simpler method of regulation,
namely the implementation of a Federal usury cap.
A. There Is No Existing Federal Law on Interest Rate Caps for Loans to
the General Public
There currently is no Federal law regulating interest rates on
consumer loans. Until 25 years ago, most U.S. States had usury laws
that capped interests on consumer loans. In the U.S., usury laws have
historically been the main protection consumers have had against harsh
credit practices. Usury dates back to the earliest recorded
civilizations and has a very prominent role in early American laws.
The Supreme Court's decision in Marquette National Bank v. First
Omaha Service Corp., \4\ concluded that the bank's State interest rate
applied when a bank lent to an out-of-State customer, and after this
decision, States began eliminating their usury caps in order to attract
financial institutions to their States, with South Dakota and Delaware
leading the way. The decision effectively deregulated State interest
rate caps. No Federal law has filled this gap, nor have other solutions
to high-cost lending been designed.
---------------------------------------------------------------------------
\4\ Marquette Nat'l Bank v. First Omaha Serv. Corp., 439 U.S. 299
(1978).
---------------------------------------------------------------------------
B. Only About a Third of States Effectively Regulate High-Cost Credit
Eighteen States plus the District of Columbia either forbid high-
cost lending or cap interest rates at 36 percent or less. The rest of
the States have either no regulation of consumer loans, have
regulations that affirmatively allow the high-cost products described
above, or have piecemeal laws that apply to one or more of the various
types of loans. The resulting legislative patchwork has kept
legislatures and consumer protections organizations busy around the
clock, but has not resulted in any overall decrease in high-cost loans
or in interest rates on such loans. To the contrary, the high-cost
lending industry is growing exponentially, faster than any other part
of the consumer credit sector and rates are going up not down.
C. The Public Supports Interest Rate Caps on Consumer Loans, Even the
Very Conservative Public
In every study or survey in which the public has been asked to
comment, the American public overwhelmingly supports Government
imposition of interest rate caps on consumer loans. A recent study I
did with psychologist Tim Goldsmith proves this point. Our entire
article is attached but other studies and survey all reach the same
result.
First, a national survey by the Center for Responsible Lending
shows that three out of four Americans who expressed an opinion think
that Congress should cap interest rates, and 72 percent feel that the
caps should be no higher than 36 percent.
State ballot initiatives glean the same results. For example, in
Montana, 72 percent of the population supported a ballot initiative
that ultimately resulted in a 36 percent cap on interest rates for all
loans in Montana. Citizens of Kentucky also voted for a ballot
initiative that ultimately capped all loans at 36 percent. Similarly,
Arizonans overwhelmingly supported a ballot initiative that ended
payday lending in the State. Additionally, in 2008, 68 percent of
Ohioans supported a ballot initiative that purported to cap interest in
the State at 28 percent.
Public opinion survey data show similar public proclivities in
favor of interest rate caps. After hearing that payday and title
lenders can charge 500 percent or more in Texas, 63 percent of Texans
age 45 or older strongly agreed that the State should cap interest
rates and fees, with 77 percent of respondents reporting that the cap
should be 36 percent or less. In another survey taken by the Texas Fair
Lending Alliance, and the Texas Faith for Fair Lending, 85 percent of
people polled favored capping interest rates on payday and auto title
loans at 36 percent APR or less. In Iowa, survey data showed that seven
in ten Iowans believe payday loan rates and fees should be capped. In
Rhode Island, the only State in New England to allow storefront payday
lending, a public opinion poll showed that 62 percent of Rhode
Islanders supported capping interest on payday loans. Finally, a public
poll of Coloradans showed that 74 percent of Coloradans support a
similar 36 percent cap.
Additionally, support for caps crosses party lines. In the attached
study by Professor Tim Goldsmith and I, we set out to measure not just
overall support for interest rate caps but political affiliation of
those who favor caps on consumer loans. Our data show widespread
support for interest rate caps across political lines. We did find that
more Democrats favor interest rate caps than Republicans, with 94
percent of Democrats favoring caps and 73 percent of Republicans
favoring caps.
What is remarkable, however, is just how many conservative people
favor caps. Our data show that over 57 percent of people who report
being ``very conservative'' politically and over 82 percent of those
who report being ``conservative'' politically favor interest rate caps
over no interest rate caps.
While wondering aloud why the public is not more active in seeking
out laws that cap interest, we stumbled upon a possible explanation.
First, many people incorrectly think interest rates are capped (over 58
percent for credit cards and over 43 percent for short-term loans),
when in reality these rates are not capped. In other words, people
misunderstand and overestimate the protection the law currently
provides. Second, even among those who know that the law provides no
caps, most are unaware that lenders in the State in which the study was
conducted currently charge interest rates of 200 percent or more.
Indeed, we found that 81 percent of the public was unaware of the costs
of these ubiquitous loans. These poll data support the notion that 300
percent to 1,000 percent loans are not normal or usual, and the public
opposes them. Interestingly, people who had themselves used the loans
were even more in favor of caps than nonusers.
D. Loopholes: How Lenders Get Around Every State Law That Is Passed,
Except Caps
Despite wide and deep public support for rate caps, uniform State
interest rate caps that apply to all consumer loan products are few and
far between. Moreover, those caps that do exist are often ineffective
due to State laws' inability to regulate certain lenders, namely online
lenders located offshore or affiliated with Indian tribes.
In States where complex statutes are passed to limit high-interest
lending, even storefront lenders find ways around those laws, by
changing the attributes of the loans to avoid the laws, fitting within
exceptions created by other laws on the books, or becoming credit
service organizations (CSOs), which are exempt from the laws. This
complex game of whack-a-mole makes regulating State by State an
expensive yet ineffective endeavor.
1. The ``Loan Term'' Loophole
Loopholes happen. In the world of payday lending, they happen a
lot. For example, payday lenders began appearing in New Mexico after
the State repealed its General Usury statute (former NMSA 1978 56-8-
11-1) in 1991. For five very long and frustrating years, the New Mexico
Legislature debated various payday lending statutes. Finally, during
the legislative session of 2007, the Legislature adopted a law is
similar to those of several other States. The regulation relies heavily
on computer database enforcement mechanism for consumer qualification
and reporting. Thirty-three States have laws that bear some similarity
to this New Mexico law. None, however, curb high-cost lending abuses,
despite legislative goals of curbing high-cost loan abuses.
The new law capped interest and fees at $15 per $100 for each
period of 14 days or less, or 390 percent per annum or more. The new
law also applied only to lenders engaged in the business of lending
amounts of $2,500.00 or less, and defined a loan covered by the Act as
one of 14 to 35 days in duration, for which the consumer gives the
lender a check or debit authorization for the amount of the loan plus
interest and fees.
In the end, this narrow definition gutted the legislation. The
industry quickly switched to loan products that fall outside the
statute, namely longer loans or those not involving a postdated check.
This was done so that lenders could charge more than 390 percent per
annum and avoid the database. Naturally, these loans that fall outside
the definition are not regulated at all. Thus, many States have spent
years attempting to regulate payday lending, but the resulting State
laws have done nothing to change short-term lending at high interest
rates.
Professor Robert Mayer reports on a similar legislative process in
Illinois:
Regulators in Illinois imposed rules in 2001 that were designed
to [curb the number of payday loans and roll-overs]. Customers
were allowed to borrow no more than $400; only two renewals
were permitted, with some of the principal paid down each time;
and a cooling-off period was mandated to prevent borrowers from
using the proceeds of a new loan to pay off the old one. The
State . . . promised to establish a database to track loan
activity and enforce the rules. \5\
---------------------------------------------------------------------------
\5\ Robert Mayer, ``One Payday, Many Payday Loans: Short-Term
Lending Abuse in Milwaukee County'' (working paper, 8), available at
http://lwvmilwaukee.org/mayer21.pdf (last accessed Aug. 6, 2009).
As in New Mexico, Illinois payday lenders quickly devised a new
product to evade the rules. The statute applied to cash advances with a
term of less than 31 days, so the industry created a 31-day loan not
covered by the rules. As a result, all of the old abuses persisted.
A 2003 Illinois OFI report acknowledged that it remains quite
common for borrowers to have multiple payday loans outstanding with
several different payday loan companies. Similar end runs occurred in
Oklahoma. Additionally, other States such as Florida, Illinois, and
Michigan have tried to impose interest-free payment plans like one
passed in New Mexico, but these laws have produced no meaningful
reduction in the number of trapped borrowers.
2. Using Exceptions Created by Other Laws To Get Around
State High-Cost Loan Laws
Other forms of loopholes also abound. In 2008, the Ohio State
Legislature voted to rescind a 12-year-old law that exempted payday
lenders from the State's usury laws, a vote Ohioans supported two to
one. An existing short-term loan law purported to cap interest on all
short-term loans at 28 percent, and also to give customers at least a
month to pay off the loans. In response, lenders simply switched their
licenses so they could offer payday loan look-alikes under two parallel
lending statutes, the Small Loan Act or the Mortgage Lending Act.
Making these changes was simple for lenders and they began offering
even higher cost loans, as this industry Web site explains:
By adjusting the loan amount to just above $500, payday loan
lenders double the loan origination fees from $15 to $30. The
Small Loan and Mortgage Lending acts allow the fees on top of
the 28 percent interest, something the new payday lending law
doesn't permit. Under the new HB 545 licensing scheme with the
check cashing fees added, customers pay the same $575 to walk
out the door with $500 in cash . . .
A First American payday loan customer indicated he previously
paid $75 for a $500 loan, First American charged him a total of
$90 to borrow the same amount after the law changed. More than
one Ohio payday loan company has structured their check cashing
and loan operations as two separate entities to justify the
fees. \6\
---------------------------------------------------------------------------
\6\ As another industry Web page explains: With news of the
passage of Issue 5 in Ohio on Nov. 4, Check Into Cash began
restructuring its loan product offerings throughout the Buckeye State
to comply with the new law. On Nov. 5, the company ceased to offer
payday loans and began offering a new product, microloans, which are
short-term loans from $50 to $600 and permitted under Ohio's Small Loan
Act. These new microloans are one way that Check Into Cash is striving
to continue to serve its valued customers with the same level of
service as it has in prior years. Even though this new Ohio legislation
was designed to make it difficult to continue serving customers who
desire payday advance services, Check Into Cash has pushed ahead,
endeavoring to persevere with its ongoing commitment to customer
service. ``Check Into Cash Committed to Serving Ohio Customers'', PRWEB
(Nov. 18, 2008, 10:19 AM), http://www.prweb.com/releases/checkintocash/
ohio/prweb1628414.htm), quoted in Martin, supra note 43, at 591 n. 151.
Then Ohio Attorney General Rich Cordray said his office found
payday loans with APR's ranging from 128 to 700 percent immediately
after the ballot initiative that purported to cap interest on consumer
loans in Ohio at 28 percent.
3. Online Lending
Internet payday lending is growing quickly and many online lenders
claim to be immune from State laws. Even where States have won cases
holding that online lenders must comply with State laws, lenders often
fail to do so. State regulators have again garnered precious resources
to enforce their laws, often to no avail. The most recent survey by the
Consumer Federation of America (CFA) notes that lenders continue to
claim choice of law from lax jurisdictions, to locate off-shore, or to
claim tribal sovereign immunity to avoid complying with State consumer
protection laws.
The trial sovereign immunity loophole is particularly troubling, as
it pits two traditionally disadvantaged groups, Native Americans and
low-income consumers, against one another in a complex battle over who
needs protection more. Under this model, lenders team up with Indian
tribes to avoid State laws. Tribes engaged in off-reservation
activities must comply with nondiscriminatory State laws, as must
anybody else. Despite this requirement, tribes are immune from suit
because they are separate sovereigns. Thus, while they must obey State
laws, they can't be sued to enforce the laws or compel their
compliance. This motivates lenders to seek out tribal partners as this
industry Web site explains:
Due to the strict regulations that are hitting the payday loan
industry hard, many lenders are now turning to Indian Tribes to
help them out. The American Indian Tribes throughout the United
States have been granted sovereign immunity which means that
they are not held subject to the laws that payday loans are
currently going up against. There are 12 States which have
banned payday lending but as long as their (sic) is an Indian
tribe who runs the operation on this sovereign land, the
lenders can continue their business even where payday loans
have already been banned. Similar to the Casino boom, payday
loans are the new financial strategy that many are using as a
loophole through the strict payday loan laws. The revenue is
quite high and promising for these tribes who often find
themselves struggling. There are approximately 35 online cash
advance and payday loan companies that are owned by American
Indian tribes. . . . It is no surprise that many lending
companies are currently seeking out American Indian Tribes in
an effort to save their businesses by escaping U.S. lending
laws. Tribal leaders are paid a few thousand dollars a month
for allowing a payday lender to incorporate on tribal land. The
more lenders that tribes allow to move onto their reservation,
the larger the profit that they make. \7\
---------------------------------------------------------------------------
\7\ ``The Connection Between Indian Tribes and Payday Lending'',
Online Cash Advance, http://www.online-cash-advance.com/financial-news/
the-connection-between-indian-tribes-and-payday-lending#ixzz1Nt1vQu6h
(last accessed Jan. 11, 2012) (on file with the author).
Often, as this excerpt clearly articulates, the lenders using this
model are not tribes. Proving that the lenders are not entitled to
tribal sovereign immunity is not easy, however. A simple Federal
interest rate cap would eliminate this loophole as even tribes are
bound by Federal law.
E. Colorado: A Middle Ground To Consider But Still 200 percent
Despite all of the failures of State high-cost lending laws to
reduce interest rates or otherwise eradicate onerous loan terms,
Colorado has passed a law that does lower those rates somewhat. This
law is worth studying for its possible implications for future Federal
legislation.
Colorado's 2010 law has reduced the number of payday loans in the
State as well as the interest rates on existing payday loans. The law
sets a maximum loan amount at $500 and adds provisions designed to keep
consumers from getting trapped in the usual payday loan roll-over
cycle. Consumers also have the right to cancel a payday loan
transaction by 5:00 p.m. the following day. Consumers may also choose
to repay loans in one sum or pay the full amount over 6 months. The law
also caps interest rates for these loans at 45 percent, but this rate
limit does not include fees and other costs, which add significantly to
the actual cost of the loans.
A recent study completed by the Pew Charitable Trust concludes that
this new law has been effective in reducing rates on payday loans. \8\
The dollar amounts of payday loans in Colorado have fallen almost 60
percent, and the number of loans fell from 1,110,224 loans in 2010 to
444,333 in 2011 after the law was implemented. Data from the Colorado
Attorney General's office indicate that the new law appears to have
dropped average effective APRs from 338.90 percent to 191.54 percent.
In addition, quite significantly, the average number of payday loans
consumers have taken out per year has fallen from 8.53 loans per person
to 2.3 loans per person.
---------------------------------------------------------------------------
\8\ Susan K. Urahn, Travis Plunkett, Nick Bourke, Alex Horowitz,
Walter Lake, and Tara Roche, ``Payday Lending in America: Policy
Solutions, Report 3 in the Payday Lending in America Series'', The Pew
Charitable Trusts, October 2013, 12-13, http://www.pewstates.org/
uploadedFiles/PCS_Assets/2013/Pew_Payday_Policy_Solutions_Oct_2013.pdf.
---------------------------------------------------------------------------
Nonetheless, the average contract finance charge has risen
significantly, from $60 to $237 and many consumer protection groups are
appalled that when fees and costs are included, the Colorado law allows
interest rates of nearly 200 percent. There also has been an increase
in ``same-day-as-payoff'' transactions, meaning the lender makes a new
loan to a consumer on the same day the consumer pays their previous
loan in full. This means lenders are easily getting around rollover
limits.
In summary, Colorado has been more vigilant than any other State in
working on a solution to the payday lending problem. The law it passed,
while better than most, still has problems.
Few States have the will or the resources to go to the efforts to
which Colorado has, making a Federal solution to the problem efficient
and effective by comparison. Congress has regularly and effectively
taken over areas of consumer and commercial law and should do so here
as well. Nevertheless, Colorado's law should be studied by Congress
before it acts.
F. Why a Federal Interest Rate Cap Would Work Best
Given the overall failure of States, a Federal usury cap is the
only option that is certain to curb high-cost lending. Coordinating 50
States on this or any issue is complex and difficult work. Congress on
the other hand need pass just one law to accomplish a national usury
cap. Consumers can and do cross borders to borrow money, and States
have no particular interest in caps. Moreover, the entire country is a
common market, such that any State's regulation of interest rates
inherently reaches across borders. Thus, there is a need for uniformity
on interest rates across those borders, which only Congress can
provide.
Congress unquestionably has the power to set Federal interest rate
caps, through the Commerce Clause of the U.S. Constitution. Indeed, in
recent years the regulation of consumer credit has become even more and
more of a Federal, rather than a State, regime.
G. The Military Lending Act as a Starting Point for Congress
Congress already has experience setting a 36 percent cap that
protects some but not all Americans. In 2007, Congress passed the
Military Lending Act (MLA), \9\ which purported to place a 36 percent
interest rate cap on consumer loans and to prohibit lenders from
engaging in predatory practices toward active-duty military members and
their dependent family members.
---------------------------------------------------------------------------
\9\ 10 U.S.C. 987(b) and 32 CFR 232.4(b).
---------------------------------------------------------------------------
In passing the MLA, military lenders were deeply concerned about
the effects of predatory lending on military readiness. When they
realized State lawmakers were unable or unwilling to pass laws
protecting the troops, these leaders focused their efforts on passing
Federal legislation. In 2006, the United States Department of Defense
issued a report finding ``that payday lending `harms the morale of
troops and their families, and adds to the cost of fielding an all-
volunteer fighting force.' '' Congress noted that lenders were
blatantly targeting the military by clustering in large numbers ``near
military bases'' and using ``military-sounding names'' and also that
military personnel lacked sophistication in financial matters and were
easily taken advantage of.
While there was early evidence that the MLA curbed predatory
lending to military communities, more recent evidence suggests that
even the MLA is mired by loopholes. However, Congress can learn from
these loopholes and pass an effective 36 percent cap, modeled after
effective State law caps. Congress can learn from the experience
gleaned from the MLA and pass a law that better serves all Americans.
Finally, the Federal Government has the power to enforce a Federal
usury cap through the Consumer Financial Protection Bureau, whereas
most States lack sufficient enforcement power.
IV. Conclusion
Based upon years of research and a great deal of contact with low-
income consumers, I honestly believe people are better off without the
option to take out unlimited numbers of high-cost loans. This is
especially true when current law in most States allows lenders to
charge 1,000 percent per annum or more in interest and fees. These
forms of credit cause far more harm than good. They are not safe, not
affordable, and thus access to them is more of burden than a benefit.
These loans make cash flow problems worse. The two ways to
eradicate cash constriction are to increase income or reduce costs.
These loans increase costs and thus worsen the problem of limited
income to meet expenses. If these loans cannot be made more affordable,
the loans should not be made.
Moreover, as long as these forms of credit are around, alternatives
for low and middle income people with poor credit will not be become
available. Where the loans are legal, high-cost lenders are everywhere,
outnumbering Starbucks, McDonald's, Burger Kings, and Walgreen's
combined. With no underwriting, they are easy (too easy) to borrow
from. As long as these lenders are in business under the terms
described here, it will be difficult for States and the Federal
Government to develop lower cost alternatives.
Thanks very much for reading and let me know if you'd like more
information on any of these points.
RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN BROWN
FROM G. MICHAEL FLORES
Q.1. Regulators have long made clear that the ability to repay
means repaying a loan without ``loan flipping,'' i.e., frequent
renewals or reborrowing. The Online Lenders Alliance study
shows as many as 57 percent of customers in some cases were
unable to pay back the loan without taking out another loan in
the same month. This study also found that 29 percent of loans
were not reported as ``paid.''
What do these findings tell us about the sustainability of
these loans?
A.1. This 57 percent metric indicates that some customers use
the product as a monthly cash flow tool and that there are a
smaller group of customers that are high frequency users and
the single pay product is not necessarily best suited for their
needs.
The 29 percent metric is indicative of high risk borrowers.
These may be outstanding loans that have yet to reach their
payment data of classified as delinquent or charged-off. As
such, higher risk equates to higher costs. In a commercial
banking environment, 3 percent delinquency is at the upper end
of acceptability for consumer loans (see http://
www.federalreserve.gov/releases/chargeoff/).
Q.2. Please describe how these findings may evidence that an
ability to pay rule is needed for these types of loans.
A.2. For short-term, low dollar loans, a better criterion is
``likelihood to repay'' rather than ``ability to repay.'' For
loans that average $400, underwriting for ability to repay
would significantly add to the cost and make originating these
loans unprofitable. Likelihood to repay measures the history of
an individual to honor their obligations for low-dollar debts
including utility payments, rent, etc.
Q.3. Payday loans are advertised as 14-day or 30-day loans.
Lenders market small-dollar credit loans, such as payday loans,
as a ``safe,'' ``sensible financial choice,'' and ``the best
alternative to meet their current needs'' for a ``one-time
fixed fee.''
Pew found that borrowers were on average indebted for 144
days, and CFPB found that they were indebted for 199 days. You
testified that the Online Lenders Alliance consumer study shows
that consumers have an average of 70 to 120 days of
indebtedness per year.
How do these findings reinforce that the short-term small-
dollar products are not in fact designed to be repaid according
to their terms?
A.3. These products are designed to meet a specific need. My
research also finds that the average advance amount has
steadily increased since 2009 which indicates a shift in
consumer needs. An installment or line of credit product may be
more suitable to meet these shifting needs. As I stated in my
testimony, the payday product fits into a continuum of credit
products starting with overdrafts and progressing in terms of
dollar amount, duration, payment scheduling, secured, etc.
Removing any of these products from the continuum creates a gap
that the consumer must fill with a less than optimal solution.
Adding products provides flexibility and choice so that the
consumer will find solutions that meet their specific
requirement or circumstance.
Q.4. As a witness at the U.S. House of Representatives
Subcommittee of Financial Institutions and Consumer Credit
hearing on access to consumer credit in 2012, you stated that
divergent States regulations ``deny alternative financial
services providers the ability to achieve scale thereby
reducing costs now associated with operating in all 50
States.''
What actions would you recommend the Consumer Financial
Protection Bureau (CFPB) take to provide a level of uniformity
and Federal oversight of these products, which would in turn
allow industry to scale products nationwide and reduce costs?
A.4. To my understanding, the CFPB provides consumer protection
oversight but cannot provide a national platform from which
standardized products are authorized to exist. I believe that
Congress must authorize a national platform.
In terms of establishing national guidelines, the CFPB
could be invaluable in going after nonlicensed, off-shore
entities that do not conform to any State or Federal statutes.
I believe that a national usury cap of 36 percent would
eliminate credit to millions of consumers who have credit
scores under 550.
Q.5. The most recent report released by the CFPB shows that 58
percent of borrowers who take out payday loans on a monthly
basis are recipients of some kind of benefits--Social Security,
SSDI, unemployment--or retirement income. The white paper the
CFPB released last year found that 22 percent of all borrowers
are on some form of public assistance or relying on retirement
income.
Payday is usually advertised as a short-term stopgap to
fill a consumer's financial needs until the borrower receives
some new source of income. This is not the case for borrowers
on a fixed income from Government assistance or in retirement.
How safe are these products for individuals living on fixed
incomes?
A.5. If indeed, there is a timing gap to pay an expense, then
the short-term advance product is appropriate.
If the premise is that benefits recipients have or will
have no other source of income in the future, then that would
say we have a group of citizens who have a permanent reliance
on benefits. I would have to disagree in that the median age of
payday loan users is 39 and that Social Security recipients may
only represent a small fraction of users. Additionally, Social
Security recipients may earn other income with no limitation
past the age of 66. Also, unemployment benefits presuppose that
the consumer will one day be employed again. Remember, these
loans are a stop gap measure and most users are only in the
product for approximately 2 years.
I do not believe that any agency can look into the needs of
individuals and State that certain products are inappropriate.
That said, there must be a variety of products available to
meet individual needs as ``one size does NOT fit all!''
Q.6. Should we be concerned that Government benefits payments
are going to companies that may be taking advantage of
borrowers?
A.6. Actually, many of these benefits are paid by the taxpayers
in terms of unemployment taxes and contributions throughout
their lifetimes toward social security. I do not believe that
the Government has a role in telling people how to spend income
that they have paid for throughout their lives.
Q.7. Payday loan contracts are considered simple in comparison
to the terms associated with other consumer credit products,
such as mortgages, credit cards, and other alternative small-
dollar loans like auto-title and installment loans. However, it
is clear that borrowers have trouble understanding and
assessing their ability to repay since consumers who use these
products are in continuous debt.
Can you explain why it is common for borrowers to
inaccurately predict their ability to repay in full the loan
and their likelihood for taking out subsequent loans?
A.7. No, I have not undertaken a behavioral study on this
subject.
Q.8. What type of disclosures would be most useful?
A.8. I am unsure if the disclosure can be any clearer. If an
expanded disclosure is inevitable, then a sample of the average
loan usage and costs incurred of the loan company's customer
base may prove useful.
Q.9. How would disclosing APRs help borrower assess the actual
cost of the loan?
A.9. I have never been a proponent on APR as a useful metric
for loans less than 1 year in duration. It is the same
reasoning that overdrafts do not disclose APR's. The fee for a
short-term advance is the most easily understood metric a
borrower can have. Consider the APR for a $100,000, 30-year
mortgage, while the APR may state 5 percent, the cost of
borrowing for the 30-year term is close to the original
principal amount. Which is more misleading, $45 for a $300
advance for 2 weeks with the APR of 320 percent or $93,256 for
a $100,000 mortgage with a 5 percent APR?
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY
FROM G. MICHAEL FLORES
Q.1. Do you think most unbanked or underbanked Americans are
capable of handling their own finances, or do you feel that
Government needs to step in and ``protect them from
themselves'' by such actions as credit rationing or denying
them certain credit products?
A.1. I believe that there should be sufficient choices for the
consumer. Most of these consumers are very capable money
managers in that they must constantly make choices of how to
spend their scarce resources.
Q.2. Some argue that States should not be rationing credit
because in some cases consumers act irresponsibly and get
deeply in debt. Do you agree, or do you support Government
stepping in and rationing credit? Some also argue that loan
prices should be set by the free market and should not be
subsidized by the Government. What do you think about this
issue? Should unbanked and underbanked consumers who pose
higher credit risks have their loans subsidized or be given
some type of governmental support, or should rates be set
through the free market?
A.2. In any population, there are a small percentage of
consumers who account for the majority of volume. The Pareto
Principle is a decision-making technique that statistically
separates a limited number of input factors as having the
greatest impact on an outcome, either desirable or undesirable.
Pareto analysis is based on the idea that 80 percent of a
project's benefit can be achieved by doing 20 percent of the
work, or conversely, 80 percent of problems are traced to 20
percent of the causes.
Regardless of the amount of credit that may be authorized
or restricted for a consumer, there will still be the Paretian
long tail distribution.
The market is the best arbiter in that most artificial
factors limiting the market will have unintended consequences.
Government subsidies are not the ultimate solution, the
answer is a robust economy with dynamic job creation and upward
mobility for consumers.
Q.3. As you undoubtedly know, the Post Office Inspector
General's Office has recently proposed that the Post Office be
allowed and encouraged to begin offering small loans and other
alternative financial services products through partnerships
with banks and credit unions. Their report claims, for example,
that the Post Office could offer a $375 loan repayable over 5
to 6 months at a rate of 28 percent APR that would generate a
profit of $48 for the Post Office (and its banking partners).
Do you find the analysis persuasive?
A.3. This is very dangerous territory for bank in that the Post
Office becomes another vendor and must be managed accordingly.
This is an example of ``rent-a-charter.'' This could create
credit and reputational risk for the bank. Also, there has not
been a successful loan model for small dollar loans that can be
profitable at 28 percent. For the past 25 years, I have advised
banks that they cannot make a profitable loan under $5,000
given their funding, operating, credit administration,
compliance and credit loss cost structures. That is why banks
used credit cards, overdrafts and home equity loans for
consumer loans.
Consider the funding costs of the loans the bank would
carry on their books. Then one must consider the operating
costs including credit administration and compliance the loss
ratio of these loan is approximately 15 percent. If one looks
at the following Federal Reserve data for consumer loan
delinquencies (see http://www.federalreserve.gov/releases/
chargeoff/delallnsa.htm), it is difficult to imagine the
regulatory not having severe heartburn over a type of credit
that exhibits a delinquency and charge-off rate greater than 5
times the banking industry's average:
Q.4. The Internet has revolutionized Americans' buying habits
and greatly increased their product choices. Consumers today,
regardless of where they are located, can obtain essentially
whatever commercial product they need when it is not available
locally by going online, getting the best available price and
having it delivered to their door. Should consumers in every
State have the same ability to get well-regulated small loans
and other financial services through the Internet if such
products are not otherwise available locally?
A.4. Yes, absolutely.
Q.5. Michael Flores' recent study, Online Short-Term Lending,
points out that the primary alternatives to payday loans are
often significantly more costly than payday loans. Given that
finding, would underserved consumers who now rely on
potentially less costly payday loans be helped or harmed if
additional States or the CFPB prohibited or severely restricted
access to these loans? If credit products like payday loans or
banks' deposit advances are eliminated, what happens to the
demand for such products?
A.5. My analysis indicates that the $5 million loss of deposit
advance products will cost consumer significantly more because
their options are limited to mush more expensive overdrafts and
slightly more expensive payday loans (if the consumer is in a
State that allows these loans).
The consumer is ultimately hurt when credit options are
limited.
If most legal credit options are eliminated and demand for
credit is not assuaged, then consumers will be forced into
unlicensed or illegal options.
Q.6. In States with arbitrary rate caps not set by the market,
are consumers who pose significantly higher credit risks really
able to get the credit they need?
A.6. It is very difficult for these consumers to access credit
from licensed and legal sources.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR MORAN
FROM G. MICHAEL FLORES
Q.1. Many have criticized what they claim is a lack of price
competition in the current marketplace for small consumer
loans. Do you believe that the current patchwork of
proscriptive State laws is limiting competition, preventing
lenders from achieving otherwise available economies of scale
or preventing innovative products from reaching a wider
marketplace? What can Congress do to help make innovative
products like Ms. Klein's company is offering in a limited
number of States accessible for all consumers?
A.1. In a more open market with consistent rules from coast to
coast, consumers will benefit from price competition from a
variety of companies wishing to compete for their business.
I believe a national operating platform that is proposed in
H.R. 1566, is a viable approach and should be considered by the
Senate.
Q.2. Given the diversity of State lending laws, is it realistic
to think that more affordable, better suited, yet commercially
viable short term installment loans that fit with today's
consumer mobility and technology trends can be offered without
some type of Congressional action?
A.2. No, there must be a national platform to allow a rollout
of products which costs can be spread across all markets.
Q.3. You mentioned that a House bill, H.R. 1566, is the best
approach suggested so far for meeting consumers' credit needs.
Can you explain why you believe this bill can provide a real
solution to the credit access problems faced by millions of
American families?
A.3. This bill will provide an operating platform to allow
companies to operate and compete for a consumer's business.
Operating in a 50 State environment will allow companies to
achieve economies of scale in order to offer price competitive
products. The more companies who compete will also push
innovation and lower process, to the ultimate benefit of the
consumer.
Q.4. When issuing rules implementing the Dodd-Frank Act, the
OCC made the following very clear and compelling comment
regarding the importance of uniform national lending standard
for national banks:
``Throughout our history, uniform national standards have
proved to be a powerful engine for prosperity and growth.
National standards for national banks have been very much a
part of this history, benefiting individuals, business and the
national economy. In the 21st Century, the Internet and the
advent of technological innovations in the creation and
delivery of financial products and services has accentuated the
geographic seamlessness of financial services markets,
highlighting the importance of uniform standards that attach
based on the product or service being provided, applying
wherever and however the product or service is provided.
However, the premise that Federally chartered institutions
would be subject to standards set at the Federal, rather than
State-by-State level, does not and should never mean that those
institutions are subject to lax standards . . . [Any] concerns
that have been expressed that Federal consumer protection rules
were not sufficiently robust should be addressed by the CFPB's
authority and mandate to write strong Federal consumer
protection standards, and its research-based and consumer-
tested rulemaking processes envisioned under the Dodd-Frank
Act.''
Isn't H.R. 1566, the House bill you mentioned that would
create a Federal charter for qualified online nonbank lenders,
aimed at giving these lenders the same operating efficiencies
as national banks, letting them to innovate by giving them the
ability to lend nationwide, subject to strong Federal
regulation, ensuring that consumers everywhere can benefit from
better, more innovative financial products, which necessitates
uniform national standards as the OCC pointed out?
A.4. Yes as I mentioned in the preceding answer.
Q.5. Your testimony notes that ``Innovative companies, many of
them operating exclusively on the Internet, are trying to
design flexible products to meet'' consumer credit demands, but
that many in industry tell you that ``real innovation is
limited'' because of diverse State lending laws. How do you see
these State laws affecting consumers as they seek to obtain
innovative, more affordable small loans and other financial
products through the Internet? Would Federal legislation open
up credit access?
A.5. The Internet is the ultimate (to date) disruptive
technology. State laws and State barriers to entry worked when
we all lived in an analogue world where consumer were limited
to products and services offered by businesses who had physical
operations in the market where the consumer lived. Some of
these State laws were designed to protect local businesses from
out-of-State competition. Businesses today must adapt to
today's realities and cannot be protected from companies who
may be able to provide a better product or service at less
expense.
While I understand the ``States' rights'' argument about
overreach by the Federal Government, it is a fait accompli that
consumers have access to products and services from all over
the globe.
I believe Federal legislation would, indeed, open up access
to credit and allow the development of a variety of products
designed to meet unique needs of consumers.
One last point I would like to make. During the
questioning, Senator Merkely asked about the Oregon law that
prohibits payday loans. While the Oregon law does have a 36
percent rate cap, it does allow for a $10 per $100 origination
fee (up to $30) for each new loan in addition to the 36 percent
interest. This is a hybrid payday product and companies can
make this loan because of the origination fee. If consumers
find this product useful for their circumstances, a national
charter would not inhibit companies from offering this loan.
------
RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN BROWN
FROM NICK BOURKE
Q.1. The FDIC and consumer groups have advocated for small-
dollar products that have four features:
a. reasonable APRs;
b. repayment period longer than 90 days;
c. ability to repay principal;
d. and the borrower demonstrates an ability to repay the
loan in full.
Some lenders have responded to criticism of the payday
product by moving toward installment loans. You stated in your
testimony that installment loans are an encouraging market
solution for consumers. As an example of an installment
product, Enova offers a 7 months and 13 months installment
product in New Mexico with APRs of 389 percent and 393 percent,
respectively.
As industry moves toward lengthening repayment terms, is it
possible to address the issue of affordability of small-dollar
credit products without addressing all four of the features
mentioned? Please explain why or why not.
A.1. In the vast majority of cases, lump-sum payday loans will
not meet any rational ability-to-repay test, requiring lenders
instead to provide installment loans that borrowers can pay off
over time. But converting a payday loan to an installment loan
will not by itself ensure that the payments are affordable.
More rigorous ability to repay standards are required, as well
as other safeguards. Pew's research has demonstrated that most
payday loan borrowers cannot afford to spend more than 5
percent of their periodic pretax income on loan payments (for
example, a typical borrower making $2,500 per month could not
afford loan payments of greater than $125 per month). Loans
that meet this 5 percent benchmark may merit streamlined
regulatory underwriting requirements if policy makers wish to
promote access to credit for those with damaged credit
histories.
However, any loan that requires periodic payments in
amounts that exceed 5 percent of a borrower's gross periodic
paycheck must be rigorously underwritten to ensure the borrower
can repay the loan and all other expenses without reborrowing.
These requirements generally will result in installment loans,
though they do not preclude the possibility of loans that could
last shorter than 90 days.
Pew does not have a specific recommendation regarding the
price of small-dollar loans that are marketed to those with
damaged credit histories. However, setting maximum allowable
prices is warranted in markets, such as this one, where there
is evidence that competition does not put downward pressure on
prices or where consumers are inherently vulnerable. Research
shows that lenders generally do not compete on price in these
markets serving those with poor credit, which is why almost
every State has laws that set maximum allowable rates on small-
dollar loans. Without regulations, prices reach levels that are
highly disproportional to lender cost, or far higher than
necessary to ensure access to credit. Colorado's payday loan
law shows it is possible to ensure widespread access to loans
of $500 or less for people with poor credit histories, at
prices far lower than those charged for conventional payday
loans. It is also possible that such credit could be available
at rates lower than the average APR of 129 percent in Colorado.
In States that have permitted higher interest rates than this,
storefronts have proliferated, with no obvious additional
benefit to consumers (for more information, see Pew's recently
released fact sheet, How State Rate Limits Affect Payday Loan
Prices).
States may reasonably choose to set maximum annualized
interest rates of 36 percent or less if they do not want payday
lenders to operate. States may also reasonably choose to allow
interest rates higher than 36 percent if they do want payday
lenders to operate. Meanwhile, the Consumer Financial
Protection Bureau must take action to ensure that all small-
dollar loans are safe and transparent. The CFPB should enact a
strong ability to repay standard, and require several
commonsense safeguards for small-dollar loans. These safeguards
include requirements for substantially equal payments that
amortize smoothly over time, and for spreading fees and costs
evenly over the life of the loan to reduce the risk of loan
flipping, i.e., lender-driven refinancing that creates long-
term indebtedness and drives up cost. More discussion is
provided in our response to Question 2 below.
For more information: Please see Pew's Policy Solutions
report (2013). Section 3 (starting at page 26) discusses
factors for ensuring affordability in installment loan markets.
Section 4 (starting at page 33) discusses important
considerations for payday loan reform, including a number of
common problems found in installment loan markets in addition
to the ability to repay problem. Pew's detailed policy
recommendations are found on pages 44-47.
For more on the lack of price competition in payday loan
markets, see How State Rate Limits Affect Payday Loan Prices
(The Pew Charitable Trusts, 2014).
A collection of Pew's research on small-dollar lending,
including summaries and interactive displays, is available at
www.pewtrusts.org/small-loans.
Q.2. You stated in your testimony that ``lenders' reliance on
long-term borrowing behavior indicates a fundamental flaw in
the business model that can only be addressed by requiring
loans to be structured differently (mainly, as installment
loans).''
What research has Pew conducted to determine if similar
roll-over behaviors are expected from an installment product?
A.2. Pew's Payday Lending in America series of reports has
demonstrated the significant gap that exists between how payday
loans are packaged and marketed (i.e., as short-term, fixed-fee
products for temporary needs) and how most borrowers experience
them (the average borrower is dealing with an endemic financial
shortfall, is in payday loan debt for 5 months, and pays $520
in finance charges, nearly ten times the advertised price of a
typical payday loan). The conventional payday loan business
model relies on this gap for its profitability. Analysis of
State regulatory data shows that nearly all lender revenue
comes from repeat borrowers: Lenders make 97 percent of their
revenue from borrowers who use three or more loans per year,
and 63 percent of revenue from those using 12 or more loans per
year. Consecutive usage is the norm. According to the CFPB, 80
percent of loans originate within 14 days of a previous loan,
and half of all loans occur within a continuous sequence often
or more loans.
Similar problems can occur in installment loan markets. For
example, installment loans with front-loaded or unaffordable
payments can lead to refinancing and nontransparent cost
structures, as described in the following excerpt from Pew's
Policy Solutions report (2013), at pages 33-34 (citations are
not included below but can be found in the original report):
When lenders can earn nonrefundable fees for
originating loans, or when they can front-load interest
during the beginning of the repayment period, they have
incentive to encourage customers to refinance, or flip,
loans. Flip is used to describe reborrowing that a
lender encourages, whereas renew and reborrow have been
used in this series to describe additional borrowing
caused by an inability to cover expenses after repaying
a loan.
Loan refinancing can give borrowers access to
additional credit when they want it. Take, for example,
a borrower in the third month of a 6-month installment
loan. The borrower might be eligible to refinance the
loan because she has paid down some of the principal.
Refinancing would provide her with cash in hand. But it
would also extend her indebtedness by pushing back the
loan's payoff date.
If lenders can use refinancing to earn more fees
immediately, or if they can calculate interest to earn
a disproportionately high share of revenue during the
loan's first few months, they have an incentive to flip
loans. This flipping places borrowers at risk of
financial harm because of the new fees, interest
payments, and additional months of debt. Excessive
refinancing also can mask delinquencies, because if
borrowers are unable to afford loan payments, lenders
can effectively let them skip a payment by agreeing to
extend the duration of their loan, a process known as
re-aging loans.
There are two lender incentives to encourage
refinancing that can cause borrowers financial harm.
[1] When small loans carry an origination fee, lenders
can earn a substantial portion of revenue at the outset
of the loan, creating a strong incentive to encourage
borrowers to refinance or pay it off and reborrow
quickly so the lender earns another origination fee. As
a result, refinancing is common in small-loan markets
that allow an origination fee to be earned in full when
the loan is made.
Lenders may rely on origination fees to provide a
measure of predictability in their revenue streams in
the event that borrowers repay the loans early. Yet
since most small-dollar loan borrowers cannot pay the
loans off quickly, lenders can rely on their paying
interest charges for several months (as in Colorado,
where the average borrower carries a loan for more than
three months even though money is saved by paying off
earlier). And although lenders might legitimately
employ such fees as compensation for the cost of
opening new loans (as ``origination fee'' suggests),
policy makers must be aware of the strong link between
origination fees and loan flipping.
In this market, lenders' desire to supplement interest
income by adding origination fees seems minor compared
with the significant risk that loan flipping poses to
consumers and the marketplace. Accordingly, policy
makers should limit the use of origination fees in
small-dollar loan markets. Possible approaches include
limiting fees to a nominal amount, restricting the
number of fees to one per borrower in a year, or, as
Colorado lawmakers have done and as Pew recommends,
requiring any fees to be spread evenly over the life of
the loan, so they would be refunded on a pro rata basis
if loans are refinanced or repaid early.
[2] In some States, lenders are allowed to use
accounting methods that overweight the accrual of
interest charges during the loan's early months,
meaning that initial payments include a relatively high
proportion of interest revenue for lenders, and
payments in later months have relatively low interest
revenue. Such front-loading methods, often known as the
``rule of 78s'' or ``sum of digits,'' incentivize
refinancing because lenders earn far more interest
income at the outset of the loan than they would using
the standard actuarial method of calculating interest
used for other financial products, such as mortgages or
auto loans.
When lenders can book much of the interest revenue
during the early months of a loan, they have an
incentive to flip loans into new ones, so that more of
these lucrative early months occur. This can lead to
practices that entice borrowers to refinance loans to
receive a fresh infusion of cash, despite the costly
net impact of front-loaded interest payments. The harm
to borrowers who refinance or pay off their loan early
is that more interest and less principal are paid than
would be paid under a conventional method of
calculating interest. Lawmakers sometimes address this
problem by requiring lenders to use the standard
actuarial method. Pew recommends this approach as well.
Of course, lenders have a natural incentive to
encourage repeat business. Default risk is higher with
new borrowers than with existing customers. It also
generally costs lenders far more to acquire a new
customer than to keep an existing one, giving them an
incentive to extend their relationships with customers,
as is true with other businesses. If a borrower can pay
off a loan and cover other expenses, and then chooses
to borrow again, this dynamic might pose no problem.
But when a lender maintains a long-term relationship
with a borrower by encouraging frequent refinancing,
the borrower does not receive the benefits of a
nominally closed-end loan. In such cases, a gap between
packaging and experience emerges and leads a borrower
to spend more and stay in debt longer than the loan's
initial terms stated.
In sum, consumers can be harmed by small-dollar
installment loans in the absence of regulations that
eliminate lender incentives to flip loans.
Q.3. Lenders offerings small-dollar installment credit products
claim they can help borrower build a credit history and improve
credit scores. Enova testified that they have been working to
foster relationships with the major credit bureaus, and hope to
help consumers build credit history.
Can you explain how these products have improved the credit
scores for individual consumers?
Conventional payday lenders making lump-sum and installment
payday loans generally do not report to credit bureaus. Nonbank
installment lenders generally do report to credit bureaus.
There has been little research on the credit score trajectory
of nonbank installment loan customers. In order for customers
to be successful in using installment loans and improve their
credit scores, it is crucial that the loan payments are
affordable and fit within their ability to repay.
It is worth noting that access to additional credit will
not lead to better outcomes for some borrowers. Customers who
turn to high-interest small-dollar loans often have very low
credit scores because they are already heavily indebted and/or
struggling to make ends meet. For example, rather than being
``thin file'' or ``no file'' consumers who are creditworthy but
lack access to mainstream credit, most payday loan borrowers
are ``thick file'' consumers who have substantial experience
with debt. More than half of payday loan borrowers carry credit
card debt, two in five own homes (many with mortgages), and
many also hold student loans, auto loans, and other debt. The
average payday loan applicant has a credit score in the low
500s, indicating an assessment by credit reporting agencies
that payday borrowers are already overburdened with debt and/or
struggling to meet financial obligations. For more information,
see Pew's Policy Solutions report (2013), at pages 26-27 (the
section entitled, ``The Limited Benefits of Access to
Credit'').
Q.4. Payday loans are advertised as 14-day or 30-day loans. As
Pew stated in the Payday Lending in America series, lenders
market small-dollar credit loans, such as payday loans, as a
``safe,'' ``sensible financial choice,'' and ``the best
alternative to meet their current needs'' for a ``onetime fixed
fee.''
You testified that borrowers were on average indebted for
144 days, and CFPB found that they were indebted for 199 days.
The Online Lenders Alliance consumer study shows that consumers
have an average of 70 to 120 days of indebtedness per year.
Please explain how do these findings reinforce that the
short-term small-dollar products are not in fact designed to be
repaid according to their terms?
A.4. These findings demonstrate a large gap between how a
product is packaged and how it is experienced. As demonstrated
below, this gap exists because of loan structures that promote
frequent refinancing and business models that cannot be
profitable without such frequent refinancing.
A. Most payday loan borrowers are in long-term financial
distress, and they turn to payday loans for funds to cover
regular monthly costs.
Payday borrowers routinely struggle to pay their
bills: 58 percent report having trouble paying regular
bills at least half the time, and one-quarter have
trouble paying bills every single month.
69 percent of payday borrowers turned to a payday
loan for help paying recurring expenses (such as rent,
mortgage, utilities, credit card bills, and so on).
B. Payday loans are fundamentally unaffordable because they
take too much of a typical borrower's next paycheck,
undermining their ability to repay the loan and keep up with
regular bills.
A typical payday loan requires a payment of $430 on
the borrower's next payday, or 36 percent of a typical
borrower's gross (pretax) paycheck.
Most borrowers can afford to pay no more than 5
percent of their pretax paycheck toward a loan while
meeting other financial obligations without having to
borrow again to make ends meet.
C. When loan payments exceed borrowers' capacity to repay,
extended usage is the norm.
Unaffordable payments lead to consecutive
reborrowing: 80 percent of payday loans originate
within 14 days of a previous loan.
The average payday borrower is in debt for 5 months
of the year, even though many borrowers sought to avoid
``more debt'' or ``another bill.''
The average borrower pays $520 in fees per year,
far higher than the $55 ``fixed fee'' for the average
payday loan.
D. The payday loan business model requires extended usage
to be profitable
Almost all payday revenue comes from repeat
borrowers: 97 percent of loans go to those using three
or more per year, and 63 percent of loans comes from
those who use 12 or more per year.
The business model is not profitable until the
average borrower uses four to five loans per year.
Payday and other small-dollar loan business models are
fundamentally reliant on this pattern of unaffordability and
reborrowing for their profitability--a fact that represents one
of the most striking failures of this marketplace and one which
policy makers have too often overlooked. Going forward,
regulators should monitor the percentage of revenue that payday
and installment lenders receive from loan refinancing, because
high rates of refinancing are indicative of poor underwriting
or other harmful practices.
Q.4. The most recent report released by the CFPB shows that 58
percent of borrowers who take out payday loans on a monthly
basis are recipients of some kind of benefits--Social Security,
SSDI, unemployment--or retirement income. The white paper the
CFPB released last year found that 22 percent of all borrowers
are on some form of public assistance or relying on retirement
income.
Payday is usually advertised as a short-term stopgap to
fill a consumer's financial needs until the borrower receives
some new source of income. This is not the case for borrowers
on a fixed income from Government assistance or in retirement.
How safe are these products for individuals living on fixed
incomes?
Should we be concerned that Government benefits payments
are going to companies that may be taking advantage of
borrowers?
A.4. Pew's research has found that 41 percent of borrowers use
a cash infusion, like a tax refund or help from family or
friends, to repay a payday loan. Academic research has found
that payday loan balances outstanding decline during the early
months of the year when tax refunds are distributed. An average
payday loan payment requires 36 percent of an average
borrower's bi-weekly income. This figure will average 15 to 20
percent for someone who receives income monthly instead. Pew's
research indicates that most borrowers can spend no more than 5
percent of their income on payday loan payments while meeting
other expenses. Therefore, without a cash infusion, many people
on fixed incomes have difficulty retiring payday loan debts
because of the loan's lump-sum payment structure.
Q.5. Payday loan contracts are considered simple in comparison
to the terms associated with other consumer credit products,
such as mortgages, credit cards, and other alternative small-
dollar credit like auto-title and installment loans. However,
it is clear that borrowers have trouble understanding and
assessing their ability to repay since consumers who use these
products are in continuous debt.
Can you explain why it is common for borrowers to
inaccurately predict their ability to repay in full the loan
and their likelihood for taking out subsequent loans?
What type of disclosures would be most useful?
How would disclosing APRs help borrower assess the actual
cost of the loan?
A.5. Under a lump-sum loan structure, only a product's 2-week
cost is clear, but very few loans are made to customers who
repay them without quickly reborrowing. This gap means that the
product's stated cost is dramatically different from how much
the borrower ultimately spends. As an example, when Colorado
had lump-sum payment loans under its previous law, the stated
cost represented only 13 percent of the dollars spent by an
average customer annually. After the law change created a
transparent installment product, the stated cost represented 87
percent of the dollars spent by an average customer annually.
Excerpts from How Borrowers Choose and Repay Payday Loans
and Policy Solutions follow:
More than three-quarters of borrowers in Pew's survey
stated that they rely on the payday lender to provide
accurate information, but information is provided only
about a two week product, even though borrowers end up
indebted for an average of 5 months. Because the loans
do not amortize, paying just the fee--the salient price
that borrowers are instructed to pay if they cannot
afford full repayment--does not reduce the amount owed,
leaving them no closer to eliminating the debt.
Therefore relying on the lender for accurate
information makes the ultimate cost and duration of the
debt extremely difficult to predict.
Financial education and disclosures are important tools
for helping people decide whether a product that many
successfully use is appropriate for them. Public
explanations and advice on the terms and conditions for
a home mortgage, student loan, auto loan, or credit
card are commonplace. Many people use these products
successfully and as advertised.
Some do not, and financial education and disclosures
can help consumers avoid the downsides of these
products. In contrast, payday loans are not used
successfully on a short-term basis by many people, and
if they were, the industry would not be profitable.
Neither disclosures nor financial education can solve
the problems caused by lump-sum repayment payday loans
because their structure hides the most common outcome--
repeated reborrowing of the original loan.
Although financial education and disclosure cannot
solve the problems with lump-sum payday loans, they
will be an important component in a properly
functioning marketplace for installment loans. When
designed to avoid the pitfalls discussed earlier in
this section, such loans can be used successfully by
many people, but they will not be appropriate for some.
In that case, financial education and clear disclosures
can help people decide whether they should borrow and
if so, whether such products are a good choice for them
and how to use those products successfully.
One method for measuring the value of financial
education and disclosures will be whether consumers
comparison-shop and seek out lower prices for loans.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY
FROM NICK BOURKE
Q.1. Do you think most unbanked or underbanked Americans are
capable of handling their own finances, or do you feel that
Government needs to step in and ``protect them from
themselves'' by such actions as credit rationing or denying
them certain credit products?
A.1. A key policy goal should be to ensure a safe and
competitive marketplace, in which all potential borrowers of
small-dollar loans can choose products based on transparent
information that allows them to predict costs accurately.
Unfortunately, there is extensive evidence that the small-
dollar loan market fails this test.
For example, consider the large gap that exists between how
a payday loan is advertised or packaged and how it is
experienced. As demonstrated below, this gap exists largely
because of loan structures that encourage frequent refinancing
and business models that cannot be profitable without such
frequent refinancing.
A. Most payday loan borrowers are in long-term financial
distress, and they turn to payday loans for funds to cover
regular monthly costs.
Payday borrowers routinely struggle to pay their
bills: 58 percent report having trouble paying regular
bills at least half the time, and one-quarter have
trouble paying bills every single month.
69 percent of payday borrowers turned to a payday
loan for help paying recurring expenses (such as rent,
mortgage, utilities, credit card bills, and so on).
B. Payday loans are fundamentally unaffordable because they
take too much of a typical borrower's next paycheck,
undermining their ability to repay the loan and keep up with
regular bills.
A typical payday loan requires a payment of $430 on
the borrower's next payday, or 36 percent of a typical
borrower's gross (pretax) paycheck.
Most borrowers can afford to pay no more than 5
percent of their pretax paycheck toward a loan while
meeting other financial obligations without having to
borrow again to make ends meet.
C. When loan payments exceed borrowers' capacity to repay,
extended usage is the norm.
Unaffordable payments lead to consecutive
reborrowing: 80 percent of payday loans originate
within 14 days of a previous loan.
The average payday borrower is in debt for 5 months
of the year, even though many borrowers sought to avoid
``more debt'' or ``another bill.''
The average borrower pays $520 in fees per year,
far higher than the $55 ``fixed fee'' for the average
payday loan.
D. The payday loan business model requires extended usage
to be profitable
Almost all payday revenue comes from repeat
borrowers: 97 percent of loans go to those using three
or more per year, and 63 percent of loans comes from
those who use 12 or more per year.
The business model is not profitable until the
average borrower uses four to five loans per year.
Payday and other small-dollar loan business models are
fundamentally reliant on this pattern of unaffordability and
reborrowing for their profitability--a fact that represents one
of the most striking failures of this marketplace and one which
policy makers have too often overlooked.
Fifteen States do not have payday lending stores, usually
because they have declined to exempt payday lenders from the
State's usury laws. Existing research is inconclusive as to
whether individuals fare better with or without access to high-
interest credit, but the research is clear that where high-
interest credit is available, borrowers who use loans with
affordable payments fare better than those who use loans with
lump-sum payments.
Some States have decided to allow high-interest credit, but
with limits on how many loans, or how much money, a customer
may borrow at a time or in a year. In Colorado, officials
recognized that payday loans were working poorly, largely
because their payments were unaffordable. The 2010 reform they
passed, requiring at least 6 months to repay in affordable
installments, instead of a 2-week balloon payment, has
succeeded as a result. An excerpt from Pew's Policy Solutions
report follows, describing why Colorado officials elected to
fix the failed balloon-payment payday loan, rather than leaving
it intact and attempting to mitigate its harm through limiting
its usage:
Some States with loan-rationing strategies have
decreased the volume of borrowing, and have saved
consumers money and protected them against some of the
financial harm from the long-term use of payday loans.
But such measures do not address the loans' fundamental
unaffordability. Furthermore, rationing amounts to a
tacit admission that the lump-sum repayment payday loan
is fundamentally broken or harmful. Rationing requires
a database to track and limit loan usage, yet State-
administered databases are not typical for other
financial products. Instead, credit decisions are
generally left to borrowers and lenders, and State
governments rarely limit usage or control borrowing
behavior.
Colorado legislators explicitly rejected loan
rationing, electing instead to address the fundamental
unaffordability of the loan rather than preserving the
product's unaffordable structure and then trying to
mitigate its harm through limiting the number of loans
or renewals. One elected official explained the
Government's intentions in replacing the old law:
``They get a loan, two weeks they have to pay $575
back. Well, they didn't have the money to begin with.
What changed in two weeks to allow them to deal with
that? Nothing. So then they were caught in a cycle. So
making it more affordable and allowing them to pay it
over 6 months . . . was key to being able to solve the
cycle of debt.''
An additional reason for rejecting a loan-rationing
approach was a dislike of databases to track loan
usage. One elected official said: ``People in Colorado
don't like those things [databases] . . . . To me,
that's like, `the Government wants to know what?' ''
Another elected official said: ``I'm opposed to that
kind of micromanagement from the Government.'' A
consumer advocate agreed that opposition to a database
was widespread: ``There's absolutely no support in our
legislature for a database from either side. In fact,
we had a database built into the bill in '08 initially,
and it caught as much flak from people on the left as
it did on the right. It was an absolute nonstarter,
which was also the problem with the loan restriction
bill that caused a great difficulty, and we had to have
a database for that in order to make it work.''
Officials in Colorado decided to focus on fixing the
problems that existed with the product, rather than
leaving it intact and placing behavioral constraints on
the borrower.
Q.2. Some argue that States should not be rationing credit
because in some cases consumers act irresponsibly and get
deeply in debt. Do you agree, or do you support Government
stepping in and rationing credit? Some also argue that loan
prices should be set by the free market and should not be
subsidized by the Government. What do you think about this
issue? Should unbanked and underbanked consumers who pose
higher credit risks have their loans subsidized or be given
some type of Governmental support, or should rates be set
through the free market?
A.2. There are many financial products that a minority of
customers use irresponsibly or poorly, while most use them
successfully, as designed. With products like these, financial
education and disclosures are good tools to preserve the
benefits of the products for most customers, but help the
minority avoid harm. In contrast, payday loans are used as
designed by few customers, and the product's balloon-payment
structure predictably leads to a situation where most borrowers
fail. Approximately 80 percent of loans are made within 2 weeks
of a previous loan's due date, indicating that customers do not
have the ability to repay the loans without quickly
reborrowing.
Unbanked consumers are generally ineligible for payday
loans, because they cannot provide access to their checking
account via postdated check or ACH as collateral for the loan.
While payday loan borrowers have poor credit scores, an excerpt
from Policy Solutions follows, explaining that the driver of
high payday loan prices is not credit loss (borrower risk):
Payday loan interest rates are not high simply because
lenders must compensate for high losses; they are high
primarily because of overhead. Although payday
borrowers generally have a damaged credit history, two-
thirds of revenue covers storefront and corporate
overhead and only one-sixth covers losses. This dynamic
helps explain why lenders do not assess ability to
repay: Underwriting reduces losses, which are already
low, but can increase costs, which are already high.
On the question of pricing, the same lenders charge similar
borrowers very different prices for the same loans, based on
State interest rate limits. In some States, lenders charge more
than double for the same loan what they charge in other States.
In States that have set lower-than-average limits on payday
loan prices (but still above 36 percent APR), access to credit
has not been significantly constrained. Another excerpt from
Policy Solutions follows:
Nearly all States have set maximum interest rate limits
for some types of loans. All 13 original colonies did
so. Today, 46 States and the District of Columbia set
limits on the interest rates that may be charged on at
least one type of small-dollar loan. Even in the 35
States that allow high-interest, lump-sum payday loans,
28 limit the permissible charges. In other words,
small-dollar loan markets normally operate with State-
mandated price limitations. Previous research finds
that payday borrowers do not focus primarily on price
when taking out a loan, but rather on convenience and
speed. Further, demand for payday loans is not
sensitive to price. The United Kingdom's Office of Fair
Trading conducted a review of the payday lending
industry in that country, which also uses lump-sum
repayments. Among its findings: ``A significant
proportion of payday borrowers have poor credit
histories, limited access to other forms of credit and/
or a pressing need of money at the point of taking out
a loan. As such they may be focused on the speed and
convenience of the loan rather than its price. Price
insensitivity among consumers is likely to weaken price
competition, thereby enabling lenders to raise their
prices without losing business.'' In such
circumstances, setting maximum allowable rates can
ensure that borrower costs resemble those in a
marketplace with price competition.
Payday loan prices vary between States but rarely
within States. Prices are determined by individual
State laws, and large companies offer the same loan at
vastly different prices in different States. In States
where conventional payday loans are offered, lenders
generally do not compete on price; they tend to cluster
prices at the maximum allowed, and then compete on
customer service and location. As shown in the
accompanying exhibit, a similar pattern emerges for
payday lenders that also make installment loans. These
lenders charge less in Colorado and Illinois, which
require lower interest rates on payday installment
loans, and more in the States that allow higher prices.
There is little evidence of firms lowering prices to
compete for customers--the expected result in a well-
functioning marketplace as described in classical
economic theory.
For more on the lack of price competition in payday loan
markets, see How State Rate Limits Affect Payday Loan Prices
(The Pew Charitable Trusts, 2014).
Q.3. As you undoubtedly know, the Post Office Inspector
General's Office has recently proposed that the Post Office be
allowed and encouraged to begin offering small loans and other
alternative financial services products through partnerships
with banks and credit unions. Their report claims, for example,
that the Post Office could offer a $375 loan repayable over 5
to 6 months at a rate of 28 percent APR that would generate a
profit of $48 for the Post Office (and its banking partners).
Do you find the analysis persuasive?
A.3. In the example cited, a customer would borrow $375 and
repay approximately $423 ($48 in interest and fees) over 5.5
months. The Inspector General's report used the example of a 25
percent annualized interest rate plus a $25 loan fee. The
resulting APR would be approximately 46 percent. Such a loan
would produce $48 in revenue, but the report did not estimate
the loan's profitability. Insufficient information about losses
and overhead is available to project the profitability of the
hypothetical loan described. Small-dollar loans are available
from some credit unions, a few nonbank alternative lenders, and
a few banks at rates similar to the one discussed here. Nonbank
lenders have lowered prices substantially when States have
reduced allowable prices (without corresponding declines in
access to credit), though no conventional storefront lenders
offer loans at prices approximating 46 percent APR.
Q.4. The Internet has revolutionized Americans' buying habits
and greatly increased their product choices. Consumers today,
regardless of where they are located, can obtain essentially
whatever commercial product they need when it is not available
locally by going online, getting the best available price and
having it delivered to their door. Should consumers in every
State have the same ability to get well-regulated small loans
and other financial services through the Internet if such
products are not otherwise available locally?
A.4. Federal standards are appropriate to ensure a basic floor
for product safety. Pew has outlined detailed policy
recommendations in order to make payday loans safer. But a
Federal charter for payday lenders would undermine the
authorities over interest rates and consumer protections that
traditionally have resided with States.
Q.5. Michael Flores' recent study, Online Short-Term Lending,
points out that the primary alternatives to payday loans are
often significantly more costly than payday loans. Given that
finding, would underserved consumers who now rely on
potentially less costly payday loans be helped or banned if
additional States or the CFPB prohibited or severely restricted
access to these loans? If credit products like payday loans or
banks' deposit advances are eliminated, what happens to the
demand for such products?
In thinking about consumers' costs, it is crucial to know
whether one product is a substitute for another, or whether it
is instead one used in addition to another. It is not clear
that payday loans on net help customers spend less on other
products, like overdraft. Demand for credit is also not fixed,
but is instead shaped by convenience, advertising, and
perceptions of providers. An excerpt on overdraft substitution
from How Borrowers Choose and Repay Payday Loans follows:
Payday loans are sometimes promoted as a cost-effective
alternative to checking account overdrafts. (A major
storefront and online payday lender encourages
borrowers to ``use payday loans to stop a bank
overdraft or NSF fee,'' and a prominent online payday
loan Web site states, ``avoid costly overdraft fees and
charges!'') However, more than half of payday loan
borrowers report having overdrafted their accounts in
the past year, and 27 percent report that a payday
lender making a withdrawal from their bank account
caused an overdraft. Moreover, Pew's prior research has
shown that the vast majority of those who overdraw
their accounts do so by mistake, not by intention.
Although people choose payday loans in order to avoid
overdrafts, many end up paying payday loan fees and
overdraft fees as well.
Although it is unclear how much payday borrowing may
reduce or increase the likelihood of checking account
overdrafts, Pew's research shows that payday loans do
not eliminate overdraft risk. Prior research has found
that some payday loan borrowers are explicitly choosing
to use the loans to avoid overdrafts and bounced
checks, but Pew's survey research demonstrates that
borrowers are incurring overdraft fees anyway.
An excerpt on credit demand from Pew's comment letter to
the OCC and FDIC follows:
Another important area to consider after a policy shift
occurs is whether customers who used a product that has
been altered will substitute an inferior product. The
CFPB's recent white paper examined the small number of
banks that offer deposit advance products. At those
banks, 15 percent of all eligible checking account
customers are utilizing deposit advances. Other data
indicate that only four percent of adults use
storefront payday loans, and even fewer use online
payday loans. In other words, where banks are offering
payday-like loans, they are experiencing very high
levels of usage compared to payday loan usage in the
general population. Conversely, where banks do not
offer such loans, there is no evidence of higher usage
of payday loan stores. Thus, it should not be assumed
that bank deposit advance borrowers will shift to
storefront or online payday loans.
Pew's research also shows that people are no more
likely to seek cash advances online when storefronts
are not unavailable in their communities. The rate of
online borrowing in States that essentially prohibit
storefront payday lending is identical to the rate of
online borrowing in States where payday loans are
available from stores. These figures have important
implications as we think about substitution as compared
with demand generation in the broader small-dollar
credit market.
Pew's research with storefront and online payday
borrowers indicates that people who find themselves
unable to pay bills are often not choosing between
formal credit products. Instead, they choose between a
variety of options, with a majority saying they would
cut back on expenses, delay paying bills, borrow from
family or friends, or sell or pawn possessions if they
did not have access to payday loans. Thus it is
important to place bank deposit advance loans in the
larger context of borrowers' decision making,
recognizing that they are choosing between many
options, and will not necessarily be motivated to seek
the services of conventional payday lenders because of
a lack of payday loan options at banks.
Because of a deposit advance's unaffordability, it is
unclear whether it functions as a substitute for other
credit products or overdrafts, or whether deposit
advance borrowers simply pay more fees as they use both
products. The CFPB report's finding that 65 percent of
deposit advance customers overdraft too is instructive.
While it is still unclear whether deposit advances on
net increase or decrease overdrafts, it is clear that
they do not eliminate overdraft risk, and most
borrowers pay fees for both.
Q.6. Your report says (p. 46) that ``PEW does not recommend law
changes in the 15 States that do not have payday lending,
because such a change may not benefit consumers.'' On the other
hand such a change may benefit consumers if they need a credit
product that State law currently prohibits. Do you think
consumers are better off with a properly structured and
regulated loan at a market based rate than to have no loan
available due to an prohibitive cap?
A.6. Lump-sum payday loans are not properly structured in the
35 States that have them, because they consistently exceed a
borrower's ability to repay (though not a lender's ability to
collect, via postdated check or ACH). As to whether people
already struggling with debt fare better with or without access
to additional high-interest credit, an excerpt from Policy
Solutions follows:
Rather than being ``thin file'' or ``no file''
consumers who are creditworthy but lack access to
mainstream credit, most payday loan borrowers are
``thick file'' consumers who have substantial
experience with debt. More than half of payday loan
applicants carry credit card debt, two in five payday
borrowers own homes (many with mortgages), and many
also hold student loans, auto loans, and other debt.
Typical payday loan applicants have poor credit scores
in the low 500s, indicating an assessment by credit
reporting agencies that payday borrowers are already
overburdened with debt and/or struggling to meet
financial obligations.
Fifty-eight percent of payday loan borrowers have
trouble paying their bills at least half the time, and
7 in 10 use loans to cover ordinary living expenses,
such as rent or utilities. Payday borrowers' having
little discretionary income helps explain why 79
percent in Pew's survey support limiting the size of a
loan repayment to a small amount of each paycheck.
Whether it is wise to use short-term credit to cope
with persistent cash shortfalls is debatable, and
policy makers surely will continue to examine the
merits of promoting credit for consumers who are
already indebted and struggling to make ends meet
especially when that credit comes at significantly
higher cost than mainstream products. It is entirely
possible that consumers who are already struggling with
debt have financial problems that cannot be solved by
obtaining more credit. But for those who use credit,
requiring loans to have affordable installment payments
that predictably amortize to a zero balance can avoid
creating an unsustainable reliance on getting new loans
to deal with shortfalls caused by repaying old ones.
Thus it becomes clear why 90 percent of payday
borrowers in Pew's survey favor allowing the loans to
be repaid in installments.
Q.7. In your written submission to this Committee dated March
24, you discussed in-depth a report from the CFPB, CFPB Data
Point: Payday Lending that was not publicly available until the
following day, March 25. How did you come to have access to
this report ahead of its public release?
A.7. Media members with embargoed copies of reports sometimes
call Pew for comment while they work on stories in advance of
an embargo lifting. In these instances, media members may share
embargoed copies of a report in order to gain Pew's perspective
on the report for their piece. Pew received the CFPB report on
March 24 in this way in order to provide comments to the media.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR VITTER
FROM NICK BOURKE
Q.1. Mr. Bourke, Harris Interactive recently conducted a
national survey that found that payday loan borrowers indicated
their experience was better than expected or as expected 96
percent of the time in regards to terms and 92 percent of the
times in regards to cost. It also found that 84 percent of
borrowers said it was very easy or somewhat easy to repay their
loans. Given this survey's result and the fact that consumers
appear to value the option of payday loans, how does this
reconcile with the ever present criticism of payday lenders
from various advocacy groups?
A.1. Pew has also found that people in difficult circumstances
are grateful to receive credit And because payday loans are
usually due on the day a customer receives income, they are
indeed repaid, though usually followed by a quick reborrow.
This additional borrowing is a result of a lump-sum repayment
that consumes an average of 36 percent of a person's bi-weekly
income. Customers usually cannot afford to cover basic expenses
after repaying a lump-sum loan. An excerpt from How Borrowers
Choose and Repay Payday Loans follows:
In deciding whether to borrow from a payday lender,
more than 3 in 4 borrowers rely on lenders to provide
accurate information about the product, and lenders
describe loans as ``safe,'' ``a sensible financial
choice,'' and ``the best alternative to meet their
current needs'' for a ``one-time fixed fee.'' The
product's stated 2-week duration appeals to the
borrower's desire for a quick cash infusion as well as
the conflicting desire not to be in ongoing debt. In
reality, both desires cannot be met. But a payday
loan's unrealistically short repayment period suggests
otherwise by enabling people in difficult situations to
think that the loan can solve their problem at an
affordable fixed cost so they can avoid asking for
help, cutting back further, or creating another ongoing
bill.
The ultimate cost and duration of the loans are highly
unpredictable and bear little resemblance to their 2-
week packaging. Average borrowers end up indebted for 5
months, paying $520 in finance charges for loans
averaging $375, largely because they see their only
choices as making a lump-sum repayment retiring their
entire debt, which they cannot afford, or paying fees
to continuously pay back and reborrow the loan, which
they can afford but which does not reduce what they
owe. Once they have borrowed, neither choice is viable,
leaving them indebted far beyond their next payday.
This experience leaves borrowers torn--grateful to have
received respectful customer service and credit when
they sought it, but feeling taken advantage of by the
loan's cost and frustrated by the difficulty of
repayment.
Q.2. A study entitled, ``Consumer Borrowing After Payday Loan
Bans'' was recently published by Jacob Goldin and Tatiana
Homonoff professors at Princeton and Cornell. The study
examines the changes in consumer borrowing behavior when they
lose access to payday loans, specifically the effect of payday
loan restrictions at the State level. The study finds that
payday loan bans do not reduce the amount of individuals who
take out alternative financial services products, but instead
force consumers to choose different inferior credit options. Do
you believe research should continue to be to done to fully
understand how regulations will affect consumers and their
access to credit, before more haphazard rules and regulations
for the short-term lending industry are enacted? Has PEW
considered increasing their research on payday lending in an
effort to focus on how to provide and not limit credit options
for consumers?
A.2. Pew has conducted extensive research on payday lending,
and has studied the literature on the topic. It is unclear
whether people fare better or worse with access to high-
interest loans, but it is very clear that they fare better with
loans that have affordable (usually installment) payments
compared to high-interest loans that have balloon payments.
Pew's policy recommendations show how loans can be better for
borrowers and viable for lenders, alleviating the substantial
problems in the small-dollar, high-cost credit marketplace. The
recommendations follow:
1. Limit Payments to an Affordable Percentage of a Borrower's Periodic
Income
Research indicates that for most borrowers, payments above
5 percent of gross periodic income are unaffordable.
Any small-dollar cash loan should be presumed to be
unaffordable, and therefore prohibited, if it requires payments
of more than 5 percent of pretax income (for example, a monthly
payment should not take more than 5 percent of gross monthly
income). Lenders should be able to overcome this presumption
only by demonstrating that a borrower has sufficient income to
make required loan payments, while meeting all other financial
obligations, without having to borrow again or draw from
savings.
This 5 percent affordability threshold, which is based on
survey research and analysis of market data, is a benchmark
that policy makers can use to identify small-dollar loans that
pose the most risk of harm or unaffordability. It generally
will result in installment loans that have terms of months,
rather than weeks, but the loan duration can be self-adjusting
depending on the income of the borrower. It is also flexible
enough to accommodate various policy choices regarding maximum
loan size, duration, or finance charge. Normal supervision can
assess compliance, so this recommendation does not necessitate
a database. Borrowers will remain responsible for deciding how
many loans to take and how often to use them.
For calculation purposes, required payments would include
principal, interest, and any fees. To discourage loan splitting
or other methods of frustrating this policy, payments from all
loans by a given lender should be considered together.
Examiners should treat frequent refinancing or ``re-aging'' of
loans as evidence of unaffordability and poor underwriting.
2. Spread Costs Evenly Over the Life of the Loan
It is important to prevent front-loading of fees and
interest on installment loans. Experience shows that front-
loading practices make the early months of the loan
disproportionately more profitable for lenders than the later
months, creating incentives for them to maximize profit by
encouraging borrowers to refinance loans before they are fully
paid off (a process known as loan ``flipping'' or
``churning'').
If fees other than interest are permitted, require them to
be earned evenly over the life of the loan. Any fees, including
origination fees, that lenders fully earn at the outset of the
loan create a risk of loan flipping. Therefore, fees should be
refundable to the borrower on a pro rata basis in the event of
early repayment.
Require all payments to be substantially equal and amortize
smoothly to a zero balance by the end of the loan's term.
Prohibit accounting methods that disproportionately accrue
interest charges during the loan's early months. Such front-
loading schemes, often known as the ``rule of 78s'' or ``sum of
digits'' methods, encourage loan flipping, because a lender
earns far more interest income at the outset of the loan than
in later months.
3. Guard Against Harmful Repayment or Collection Practices
Payday and deposit advance lenders have direct access to
borrowers' bank accounts for collecting loan repayment. Lenders
use this access to ensure that they are paid ahead of other
creditors, an advantage that allows them to make loans without
having to assess the borrower's ability to repay the debt while
also meeting other obligations. Although this arrangement
shields the lender from certain risks and may facilitate
lending to those with poor or damaged credit, it comes at the
cost of making consumers vulnerable to aggressive or
unscrupulous practices. High rates of bounced checks or
declined electronic payments are indicators of such practices.
Borrowers lose control over their income and are unable to pay
landlords or other creditors first.
Treat deferred presentments as a dangerous form of loan
collateral that should be prohibited or strictly constrained.
Deferred presentment or deferred deposit loans require
borrowers to give the lender the right to withdraw payment from
the borrower's bank account. This requirement is fulfilled
through a personal check that is postdated to the borrower's
next payday or through a nonrevocable electronic debit
authorization. Because of the inherent dangers, State laws
generally authorize deferred presentments only for loans that
are understood to serve short-term, urgent liquidity needs. Of
the States that have deferred deposit loans, a majority set the
maximum term at 6 months or less, and a majority set the
maximum loan amount at $500 or less.
Policy makers may reasonably choose to prohibit deferred
presentments if they do not want payday lenders to operate. If
allowed, deferred presentments should never apply for more than
6 months or for loans of more than $500.
Prevent unscrupulous lenders from abusing the electronic
payments system, and make it easier for consumers to cancel
electronic payment plans. Some installment lenders establish
automatic repayment plans using electronic payment networks.
Although this mechanism can help lower the cost of small-dollar
loans and make loan management more convenient, evidence shows
that it also exposes consumers and their checking accounts to
significant risk. Regulators should establish a balance between
lender and borrower interests, especially in cases--such as
online lending markets--where there is evidence of aggressive
lending or collections behavior. Pew recommends making it
easier for consumers to stop automatic withdrawals, placing
limits on the number of NSF fees that borrowers may pay, and
closing the electronic payments system to merchants that abuse
it (as evidenced by repeated attempts to withdraw funds from
borrower accounts, excessive use of NSF fees, or other
aggressive behavior). These goals may be accomplished through
regulatory action and stronger oversight of the electronic
payments system by the banks that operate it.
Monitor and respond to signs of excessively long loan
terms. Some high-interest installment payday lenders set
excessively long loan terms, with only a small portion of each
payment reducing the loan's balance. Therefore, policy makers
should consider establishing maximum loan terms. These should
take into account a borrower's financial capability, measured
by income or ability to repay, as well as the size of the loan
principal. Colorado demonstrates that for average payday
borrowers, 6 months is long enough to repay $500, and in
consumer finance installment loan markets, approximately 1 year
is usually sufficient to repay $1,000.
4. Require Concise Disclosures That Reflect Both Periodic and Total
Costs
Research shows that small-dollar loan borrowers focus on
the periodic cost of borrowing but often struggle to evaluate
overall cost, making it difficult to compare other loan options
or to decide whether to borrow, adjust budgets, or take other
actions. All loan offers should clearly disclose:
The periodic payment due.
The total amount to be repaid over the life of the
loan.
The total finance charges over the life of the
loan.
The effective annual percentage rate, or APR, of
the loan.
These four numbers should be displayed clearly, and with
equal weight, to encourage borrowers to consider both periodic
and long-term costs. To facilitate comparison shopping, all
loan costs should be stated as interest, or interest plus a
standard fee. If a fee is permitted in addition to interest, it
should be included in the calculation of finance charges and
APR, based on the loan's stated term. As with other consumer
financial products such as credit cards, regulators should
require simple, standardized disclosures showing maximum
allowable charges at the time of application as well.
5. Continue To Set Maximum Allowable Charges on Loans for Those With
Poor Credit
Research shows that lenders generally do not compete on
price in these markets serving those with poor credit, which is
why almost every State has laws that set maximum allowable
rates on small-dollar loans. Without regulations, prices reach
levels that are highly disproportional to lender cost, or far
higher than necessary to ensure access to credit. Colorado's
payday loan law shows it is possible to ensure widespread
access to loans of $500 or less for people with poor credit
histories, at prices far lower than those charged for
conventional payday loans. It is also possible that such credit
could be available at rates lower than the average APR of 129
percent in Colorado. In States that have permitted higher
interest rates than this, storefronts have proliferated, with
no obvious additional benefit to consumers.
States may reasonably choose to set maximum annualized
interest rates of 36 percent or less if they do not want payday
lenders to operate. States may also reasonably choose to allow
interest rates higher than 36 percent if they do want payday
lenders to operate. But even when regulations require all loans
to have affordable repayment structures, there is insufficient
research to know whether consumers will fare best with or
without access to high-interest installment loans. Thus Pew
does not recommend law changes in the 15 States that do not
have payday lending, because such a change may not benefit
consumers. In the 35 States that have conventional lump-sum
payday lending, lawmakers should require loans to have
affordable payments and then set maximum annualized interest
rates according to whether they want payday lenders to operate.
These recommendations are intended to apply to all consumer
cash loans of several thousand dollars or less, regardless of
provider type (bank, nonbank) or product type (payday loan,
installment loan, cash advance), exclusive of loans secured
through pledge or deposit of property. They are based on
findings documented in Pew's Payday Lending in America series,
available at: www.pewtrusts.org/small-loans.
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RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN BROWN
FROM NATHALIE MARTIN
Q.1. The FDIC and consumer groups have advocated for small-
dollar products that have four features:
a. reasonable APRs;
b. repayment period longer than 90 days;
c. ability to repay principal;
d. and the borrower demonstrates an ability to repay the
loan in full.
Some in the industry have responded to this criticism of
the payday product by moving toward installment loans. Enova
offers a 7 months and 13 months installment product in New
Mexico with APRs of 389 percent and 393 percent, respectively.
As industry moves toward the lengthening repayment terms,
is it possible to address the issue of affordability of small-
dollar credit products without addressing all four of the
features mentioned? Please explain.
A.1. In my opinion no.
Q.2. Payday loans are advertised as 14-day or 30-day loans.
Lenders market small-dollar credit loans, such as payday loans,
as a ``safe,'' ``sensible financial choice,'' and ``the best
alternative to meet their current needs'' for a ``one-time
fixed fee.'' Pew found that borrowers were on average indebted
for 144 days, and CFPB found that they were indebted for 199
days. The Online Lenders Alliance consumer study shows that
consumers have an average of 70 to 120 days of indebtedness per
year.
How do these findings reinforce that the short-term small-
dollar products are not in fact designed to be repaid according
to their terms?
A.2. The findings absolutely lead to this conclusion. The
entire business model is based upon repeat users, and the
industry has said so in many contexts publicly. This fact comes
out in litigation all over the country, as well as in empirical
studies. There is little profit in the short term use.
The CFPB report released in March also showed that for
first time users, 15 percent of customers pay off and don't go
back. 20 percent default. That means 64 percent do not use
these as a short term product. Those 64 percent are the bread
and butter of the business model, the ones the lenders want in
their portfolios.
Q.3. In your written testimony you stated that ``in States
where complex statutes are passed to limit high-interest
lending . . . lenders find ways around those laws by changing
the attributes of the loans to avoid the laws, fitting within
exceptions created by other laws on the books, or becoming
credit service organizations (CSOs), which are exempt from the
laws.'' You further stated this is a `` . . . complex game of
whack-a-mole makes regulating State by State an expensive yet
ineffective endeavor.''
How would you propose addressing this issue?
What actions would you recommend the Consumer Financial
Protection Bureau (CFPB) take to provide a level of uniformity
and Federal oversight of these products?
A.3. The CFPB should implement broad rules that apply to all
small dollar loans products, that require underwriting to
ensure the borrower can pay his or her regular bills and also
repay the loans, both principal and interest. The CFPB should
limit the number of loans that can be taken out and require
that in order to be enforceable, the loans must be placed in a
national database and tracked.
Q.4. The most recent report released by the CFPB shows that 58
percent of borrowers who take out payday loans on a monthly
basis are recipients of some kind of benefits--Social Security,
SSDI, unemployment--or retirement income. The White Paper they
released last year found that 22 percent of all borrowers are
on some form of public assistance or relying on retirement
income.
Payday is usually advertised as a short-term stopgap to
fill a consumer's financial needs until the borrower receives
some new source of income. This is not the case for borrowers
on a fixed income from Government assistance or in retirement.
How safe are these products for individuals living on fixed
incomes?
A.4. The products are unsafe for almost everyone who uses them
(the exception being those with real, rare, emergencies who
expect a great deal more income or assets in the future). They
are particularly bad for those on fixed income. These loans
make it much harder to make ends meet during the next benefit
period. I also know some lenders specialize in ``serving''
people on disability or social security. They know the
borrowers involved will never be able to pay back the principal
and that is part of the business palm.
Q.5. Should we be concerned that Government benefits payments
are going to companies that may be taking advantage of
borrowers?
A.5. This is a huge problem and yes we should be very
concerned. As mentioned above, I have heard of a small town in
New Mexico where five lenders line main street and all or four
of five specialize in making loans to people who receive public
benefits. This is how I learned firsthand that lenders do not
want anyone paying off the principal. It would clearly be
impossible the way they loan to people on such a low fixed
income. That is part of the model. Make loans that people will
not be able to pay off and make money on fees forever.
We know lenders also discourage people from paying off
their loans and in one reported case in New Mexico, an employee
of a lender told a borrower that the borrower was better off
using their tax return at Walmart. That opinion is attached.
Some lenders also call borrowers on their way home from
repaying a loan and offer them another loan, this time in a
larger amount, perhaps in hope that this time, the loan will
not be paid off.
There are other situations in which this same thing is
happening, meaning that Federal benefits are going to high-cost
lenders. For example, some tax preparers themselves take most
of the primary welfare benefit in America today, the earned
income tax credit, which is designed to alleviate poverty. In
both cases, the situation you mentioned and the situation with
the tax preparers, we are literally funneling taxpayers' money
away from the intended beneficiaries and into the lender's
pockets. The lenders in turn give political campaign
contributions to politicians who will ensure that the law
continues to support these practices. No one benefits except
the lenders and the politicians who get the contributions.
Everyone else in society suffers.
Q.6. Payday loan contracts are considered simple in comparison
to the terms associated with other consumer credit products,
such as mortgages, credit cards, and other alternative small-
dollar credit like auto-title and installment loans. However,
it is clear that borrowers have trouble understanding and
assessing their ability to repay since consumers who use these
products are in continuous debt.
Can you explain why it is common for borrowers to
inaccurately predict their ability to repay in full the loan
and their likelihood for taking out subsequent loans?
A.6. Some borrowers are confused about the rate because the
rates are stated in terms on $15 per $100 borrowed or $20 per
$100 borrowed. They think this is 15 or 20 percent per annum
but the rate is just for 2 weeks or less. The actual interest
rate on such a loan is 390-500 percent per annum. They think it
sounds cheaper than a 25 percent credit card, for example. Also
people in society have trouble doing math.
Q.7. What type of disclosures would be most useful?
How would disclosing APRs help borrower assess the actual
cost of the loan?
A.7. There was a great study done where researchers wrote the
APRs and some other information on the outside of the envelope
people received when applying for a payday loan. See Marianne
Bertrand and Adair Morse, Information Disclosure, Cognitive
Biases and Payday Borrowing, University of Chicago Booth School
of Business (2009), available at http://ssrn.com/
abstract=1532213, last accessed August 7, 2013. This approach
worked meaning that people who had other options or did not
really need the money were deterred from taking out the loans.
The approach taken in this article should be considered
carefully.
In my experience, lenders try not to draw attention to the
APR, try to distract borrowers from seeing it, if they provide
the APR at all.
Q.8. Lenders offerings small-dollar installment credit products
claim they can help borrower build a credit history and improve
credit scores. Enova testified that they have been working to
foster relationships with the major credit bureaus, and hope to
help consumers build credit history.
Can you explain how these products have improved the credit
scores for individual consumers?
A.8. Very few high-cost lenders report to the credit agencies
meaning that use of these products has helped very few. I do
know that World Finance has big signs outside their storefronts
saying that they do report to credit agencies. I suppose this
could help a few consumers and I know for fact that some
consumers use this lender for that reason, rather than other
high-cost lenders. Of course some people will ultimately
default on high-cost loans and the reporting will hurt those
consumers.
I would like to know specifically what Enova has actually
done to help consumers on this issue.
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RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY
FROM NATHALIE MARTIN
Q.1. Do you think most unbanked or underbanked Americans are
capable of handling their own finances, or do you feel that
Government needs to step in and ``protect them from
themselves'' by such actions as credit rationing or denying
them certain credit products?
A.1. What the Government needs to do is to listen to what the
American people have to say about regulating high cost loans,
rather than to this industry and the politicians who have
received campaign contributions from them. The American public,
including people from both political parties, has spoken loudly
and clearly. The public favors interest rate caps of 36 percent
or less on all consumer loan products. No survey or empirical
study has found otherwise. This country has always had double
digit interest rate caps since its founding. Interest rate caps
are part of our culture and our heritage. They are also common
in other developed democracies. Having no caps is a relatively
recent phenomenon, beginning in the late 1970s and early 1980s.
Most people are shocked and disturbed to hear that it is legal
to lend money at over 36 percent and some think that 36 percent
is itself abusive.
What is presumptuous and paternalistic is for politicians
to listen to the high-cost loan industry rather than their
constituents on this point. If constituents knew their own
elected officials' true views and voting records on these
issues, the public might vote certain politicians out of
office.
Q.2. Some argue that States should not be rationing credit
because in some cases consumers act irresponsibly and get
deeply in debt. Do you agree, or do you support Government
stepping in and rationing credit? Some also argue that loan
prices should be set by the free market and should not be
subsidized by the Government. What do you think about this
issue? Should unbanked and underbanked consumers who pose
higher credit risks have their loans subsidized or be given
some type of governmental support, or should rates be set
through the free market?
A.2. Rationing is having the Government allow only a particular
amount of something (such as gasoline or food) when there is a
shortage. Clever use of the word, but I am not buying it. There
has never been more credit in any economic system in history
than what we have seen in the United States in the last decade.
As a society, we do the opposite of rationing credit. The
U.S. recently has given virtually unlimited credit to people
who have no way of paying it back, helping them dig a deeper
financial hole and providing more barriers to entry to the
middle class. There is more credit in the system than there
should be, evidenced by the recent financial crisis. We gorged
ourselves on it and it crashed the global economy.
My own research and that of many others show that people
take out many payday and title loans, then default, yet lenders
still make money off the loans.
Existing mainstream lenders could serve more low-end
consumers and still make a profit. They have chosen not to.
They would just rather invest in options that are more
profitable, like high-cost lenders.
Even assuming that some credit options will go away based
upon future regulation, this is not rationing. I think
consumers will be better off once some of the market players
are gone. Twenty-two States plus the District of Columbia
agree. This is not radical, just common sense. Credit at any
cost? No think you. Some loans are bad enough that they should
be illegal and are illegal in many States.
Q.3. As you undoubtedly know, the Post Office Inspector
General's Office has recently proposed that the Post Office be
allowed and encouraged to begin offering small loans and other
alternative financial services products through partnerships
with banks and credit unions. Their report claims, for example,
that the Post Office could offer a $375 loan repayable over 5
to 6 months at a rate of 28 percent APR that would generate a
profit of $48 for the Post Office (and its banking partners).
Do you find the analysis persuasive?
A.3. So far this is not an analysis. Feasibility and
profitability studies still need to be done. What is exciting
about the model, which is used in many countries around the
world, and exciting about the idea in general, is that the
infrastructure of the post office already exists.
The U.S. postal service is being forced by Congress to
prefund retiree health benefits, which itself is a questionable
requirement imposed by Congress. If Congress is going to stick
with this requirement, it should in turn approve the USPS to
provide these loans. This would be a way to use the huge postal
infrastructure to benefit consumers. Of course this assumes the
resulting credit would be cheaper for consumers, something the
future studies would have to confirm. The studies would also
need to confirm that the post offices would generate at least
some minimal income but on this side of the equation, it seems
they would. Even a little profit for the post office would be a
win-win. The post offices are already in operation and adding
this feature would not significantly increase overhead or
operations costs.
Banks might themselves complain about how this could
conceivably eat into their profits but do they have the
standing to make that argument, now that they have pulled
branches out of so many neighborhoods while at the same time
providing funding and infrastructure for the high-cost lending
industry? Let's hope not.
Q.4. The Internet has revolutionized Americans' buying habits
and greatly increased their product choices. Consumers today,
regardless of where they are located, can obtain essentially
whatever commercial product they need when it is not available
locally by going online, getting the best available price and
having it delivered to their door. Should consumers in every
State have the same ability to get well-regulated small loans
and other financial services through the Internet if such
products are not otherwise available locally?
A.4. Absolutely. Of course the question is ``what is a well-
regulated loan?'' For me, it includes a reasonable interest
rate, underwriting for ability to pay both regular bills and
principal and interest on the loans, and a limit on the total
number of loans a consumer can take out.
Q.5. Michael Flores' recent study, Online Short-Term Lending,
points out that the primary alternatives to payday loans are
often significantly more costly than payday loans. Given that
finding, would underserved consumers who now rely on
potentially less costly payday loans be helped or harmed if
additional States or the CFPB prohibited or severely restricted
access to these loans? If credit products like payday loans or
banks' deposit advances are eliminated, what happens to the
demand for such products?
A.5. I strongly disagree with the idea that payday loans and
other high-cost loans of 400-1,100 percent interest are cheaper
than these other costs, overdraft fees, etc. . . . The data do
not uniformly support this conclusion. Moreover, many studies
show that people are better off once payday and other high-cost
lenders leave their State. I have seen no proof from any source
that people are better off in places where high-cost loans are
available. If anything, the opposite is true.
Q.6. Do you support or oppose the PEW recommendations? Could
you please explain your reasoning?
A.6. I am not familiar with all of the PEW recommendations, but
can agree that these features are needed in the short-term loan
market:
reasonable APRs;
repayment periods longer than 90 days;
loan structures that permit borrowers to repay
principal along with interest as a loan progresses; and
underwriting for all loans.
I myself believe that other features are also desirable.
There must be a limit on the number of loans people can have
out at any one time on order to make the underwriting make
sense. Also, I am less inclined to favor a law like Colorado's,
which allows interest rates of up to 200 percent, and less
tolerant in general of triple digit interest rates. This is in
part because I have seen the harm done to many consumers who
are stuck in these loans for long periods of time, and who are
deeply sorry they took out the loans, and also because I know
the public supports interest rate caps, even the conservative
public.
Additional Material Supplied for the Record
LETTER FROM THOMAS J. CURRY, COMPTROLLER OF THE CURRENCY, SUBMITTED BY
CHAIRMAN BROWN
LETTER FROM JOHN W. RYAN, PRESIDENT AND CEO, CONFERENCE OF STATE BANK
SUPERVISORS
STATEMENT SUBMITTED BY THE AMERICAN FINANCIAL SERVICES ASSOCIATION
EMAIL SUBMITTED BY SENATOR VITTER