NAFSA leads tribal online lending and financial services from the front. Our members offer innovative, sustainable products and services to the millions of credit invisible and underbanked Americans. The products and services anchor NAFSA’s mission and vision to improve the welfare of sovereign tribal nations through e-commerce. Evidence is increasingly mounting against the long-term viability of payday loans. Recognizing the need to be nimble and progressive, NAFSA is actively working with its members to evolve their offerings and provide responsible and sustainable products in the FinTech industry.
Payday loans are characterized by a single payment structure with the full amount of the loan due at the borrower’s next pay period, typically within 14-30 days from issuance. Payday loans are part of the larger short term, small dollar loan market and accounted for an estimated $6.7 billion in revenues in 2016. Payday loans are available from physical store locations in many states and online across the country. In 2005, payday lending storefronts in the United States outnumbered McDonald’s, Burger King, Sears, J.C. Penneys, and Target stores combined. Due to tightening state and federal regulation and competition from more palatable short term credit options, revenues for storefront and online payday loans fell in 2016 an estimated 23.4% and 22.5% respectively.
One major reason payday loans are falling out of favor with borrowers and government regulators is the issue of “loan churn.” Loan churn occurs when a lender allows the borrower to take out a new loan immediately after repaying an old loan. For consumers seeking a short term solution to an emergency or cash flow problem, payday loan churn can create an inescapable cycle of debt.
From 1999-2012, the default rate on payday loans in Minnesota was only 2.1%. On first glance, this rate appears significantly less than other common alternative financial products like “Buy Here Pay Here” car loans (31.32%), pawn shop loans (30%-50%), and auto title loans (20%). With each of the other three products, the loan is secured to an item or vehicle as collateral. However, payday loans are unsecured financial products, and lenders have few remedies to recuperate the loan following default. While only 2.1% of payday borrowers defaulted in Minnesota over a decade, a 2008 study by the Center for Responsible Lending found that 76% of payday loan volume comes from repeat borrowers. More recently, the Consumer Financial Protection Bureau (CFPB) placed the loan churn rate at something closer to 80%.
In contrast to loan churn rates as high as 80%, installment loans- short term loans repaid incrementally over the course of months- tend to have significantly less churn. Data provided to NAFSA by one of its members showed that only 16% of its borrowers had taken out at least ten loans in the past year. The financial flexibility offered by smaller monthly payments under the installment model helps families make strong financial choices, manage their repayment more directly and avoid spiraling into a churning debt cycle.
Although only 2.1% of payday loans ended up in default in the Minnesota study, other research points to higher chances that a payday borrower will ultimately default at some point in the cycle. In a study by the Center for Responsible Lending, payday loan default rates were nearly 50% for borrowers within two years. Almost half of those that defaulted did so within their first two loans.
“Invisible defaults” were also an issue. An invisible default occurs when a borrower does not have sufficient funds in their bank account on the day the loan payment is withdrawn. Instead of defaulting with the lender, the borrower is now indebted to the bank via overdraft fees. About one-third of the borrowers in the study experienced an invisible default. To ensure that borrowers have more control over repayment, NAFSA Best Practices prohibits automatic debit of payments. This is just one way in which NAFSA members ensure customers have more financial flexibility and freedom to choose a repayment method that fits the needs of lender and borrower.
The data surrounding payday loan churn evidences a business model often contingent on a borrower’s inability to escape debt. Such practices only serve to exploit a consumer base with few traditional credit options in immediate need. NAFSA condemns practices that cause loan churn and will continue to work with its members to provide consumers with responsible, sustainable, and innovative financial solutions.
