Access to credit has become a necessity for modern American living, touching virtually every aspect of our lives. You need credit to buy a house or a car, pay for medical expenses, even rent an apartment. Obstacles to affordable credit can create obstacles to work. Without a car and a place to live, a job is difficult to maintain. Simply put, credit enables individuals and families to create the basic building blocks of a healthy and prosperous life.
Unfortunately, a number of factors, including insufficient income, existing debt, and a tainted or non-existent credit history affect low- to moderate-income borrowers’ ability to access affordable credit through mainstream financial institutions. Credit access is also exacerbated by a paucity of mainstream financial outlets in low-income neighbourhoods. When households with limited access to affordable credit face emergency situations that threaten their ability to work—like illness or car repairs—they often have no choice but to take any credit that they are offered, often at prohibitive rates of interest.
Storefronts advertising ‘quick-cash fast’ line the streets in commercial areas of low-income neighborhoods and market high-cost products to working-poor households. Some states enforce usury laws and interest-rate caps that adequately protect consumers from the worst of these practices but many, including Oklahoma, do not. One common source of short-term, high-cost credit for households facing acute cash-flow problems are payday loans. Payday lenders began operating in Oklahoma in 2003 after the state legislature passed the Deferred Deposit Lending Act setting minimum standards for their operation.
Predatory payday lending is the practice of making several small, consecutive, short-term loans at an average APR of around 400 percent. Opponents of the practice maintain that these loans trap borrowers in a cycle of debt. The Center for Responsible Lending (CRL) found that out of the total volume of payday loans in 2009 76 percent were ‘churned’ loans – consecutive pay period transactions. As the CRL describes, “This rapid re-borrowing indicates that most payday borrowers are not able to clear a monthly billing cycle without borrowing again.” To lessen the risk of a debt trap, Oklahoma law technically prohibits renewal or rollover of a payday loan. However, since it also permits borrowers to have more than one outstanding loan at a time, the rollover provision is functionally unenforceable.
There are 404 payday-lending storefronts in Oklahoma as of June 2010. That’s more than the number of Walmarts and McDonalds in the state combined. A standard payday loan is made for between $100-$500 for a two-week period with consumers promising to pay off the loan with their next paycheck. Payday lenders are disproportionately concentrated in Tulsa and Oklahoma County, two metropolitan counties containing roughly a third of the state’s population, but half the payday lenders.
There are 15 states that prohibit payday lending outright or have effectively prohibited the practice by enacting a hard cap on interest rates of 36 percent APR. In 2007, federal law barred consumer credit products with an APR of over 36 percent from being sold to military families. Assuming the average transaction fee ($51.93) and transaction amount ($388.12) in 2010, an Oklahoma borrower is paying an APR of 349 percent on a standard 14-day loan.
Industry representatives and defenders of high-cost short-term lending insist that churned loans are not the norm and that their products serve an important need — providing emergency cash to consumers who would not otherwise have access to credit. However, data collected through Oklahoma’s payday loan database show that only 5.4 percent of the total loan volume went to borrowers who took out between 1 and 3 loans over the course of a year. The bulk of the loans, 61.3 percent, went to customers who took out between 12 and 40 loans in one year.
To investigate the claim that payday loans are a temporary and helpful form of short-term credit for low-income families, a researcher at the Kellogg School of Management at Northwestern University recently analyzed survey data from over 40,000 households over several years. Brian Melzer found no evidence that payday loans helped alleviate economic hardship. Rather, payday loan access was correlated with increased difficulty paying mortgage, rent and utilities. The analysis concluded that:
Contrary to the view that improving credit access facilitates important expenditures, the empirical results suggest that, for some low-income households, the debt service burden imposed by borrowing inhibits their ability to pay important bills.
While it’s true that access to credit is a problem for low-income Oklahomans, payday loans are no solution. Low- to moderate-income Oklahomans need short-term and emergency loan products on fair and reasonable terms and some banks and credit unions have successfully experimented with such products. You can read more about mainstream financial institution innovations in Oklahoma Assets upcoming issue brief on affordable lending and in an upcoming blog post.
In addition to substitute products to serve low-income communities, we also need regulatory action. One solution would be to enact the same interest rate cap for civilian households that military leadership felt was necessary to protect active duty households – 36 percent. Short of a hard cap, state regulators could also do more to prevent loan rollover by extending the term of a loan from 14 days to 30. They could also limit borrowers to a single outstanding loan at a time and limit the numbers of transactions per borrower per year, ensuring that consumers don’t get trapped on a debt treadmill that will only pull them ever-further away from financial security.
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