The payday loan industry is changing, but its new products may just offer consumers a different path to a money hole.
Payday lenders are increasingly turning to installment loans, with all of the largest U.S. payday loan companies now selling the products, according to new research from Pew Charitable Trusts. Instead of requiring repayment of a loan in days or weeks, these products are repayable over several months.
At first glance, these loans may seem like a better deal for borrowers because they provide more time to repay the lender, and consumers tend to prefer an installment payment structure, Pew found. Still, the foundation warns that installment loans carry many of the same characteristics as traditional payday loans, such as sky-high interest rates. And lenders are turning to installment loans in part because the products circumvent some national regulations and the Consumer Financial Protection Bureau (CFPB) has proposed payday loan rules.
“Ohio is the poster child for one of the worst examples of this,” said Nick Bourke, director of the Small Dollar Loans Project at Pew Charitable Trusts. “They tried to regulate, but what they did ended up encouraging payday lenders to give out installment loans… They didn’t put anything in the law that governs how these new payday loans work. Lenders are actually making loans outside of regulation.”
Payday and auto title lenders sell installment loans in 26 of the 39 states where they currently operate. In some states, they operate under credit service organization statutes, which allow businesses to negotiate loans, such as in Ohio and Texas. Payday lenders charge borrowers fees for brokerage loans that are sold to other lenders, circumventing laws in some states that cap interest rates.
“This brokerage is an evasion of low interest rate limits because the fees charged are in addition to the interest paid to the third-party lender and significantly increase borrower costs,” the Pew report notes.
The CFPB said it has done extensive research on high-cost installment plans and found that more than a third of loan streaks end in default, often after the borrower has refinanced or re-borrowed.
“The CFPB’s proposed rule would cover lenders making high-cost installment loans where the lender has the ability to extract payment from the consumer’s bank account or salary, or where the lender takes a security interest in the consumer’s vehicle. “said CFPB spokesman Sam Gilford. said in an email. “Lenders would be required to assess the borrower’s ability to repay the loan, and the proposal sets out a specific and clear methodology for lenders to use.”
Ohio regulations limit payday loans to an interest rate of 28%, but by negotiating loans, lenders get away with charging significantly more, according to the research. In one example, a $500 installment loan in Ohio with a 26-week repayment schedule has an APR of 360%, the researchers found.
In another case from Ohio, a consumer complained to the CFPB that he took out a 47-month payday loan that was immediately transferred to another lender. After several months, the borrower could no longer continue to make the payments. The consumer, who said the lender called family and friends and threatened legal action, eventually provided a Social Security credit card.
This complaint illustrates a problem with installment loans: they seem to offer borrowers more flexibility, but they share the same risk as shorter-term payday loans that borrowers will be trapped in an unaffordable debt repayment cycle.
In other words, installment plans don’t match affordability. Installment payday loans typically consume between 7 and 12 percent of the average borrower’s gross monthly income, which is above the 5 percent affordability threshold, according to the research.
Due to the threat of regulation from the CFPB and increasing scrutiny from state legislators, payday lenders increasingly seem to be shifting their business models to installment lenders. Payday lenders in Texas increased revenue from installment loans from 27% of revenue in 2012 to 67% last year, Pew said.
Pew wants state and federal lawmakers to pass legislation that would limit over-term loans, unaffordable payments, up-front fees and uncompetitive pricing.