For payday lenders, installment loans could soon become the new normal, as a result of proposed government regulations that would crack the whip on payday debt traps. Under the existing model, a credit check is not required, and the lender simply confirms that you have a steady source of income before approving your loan application. Due-date extensions are available for an additional fee. (For more, see How Installment Loans Work.)
In an effort to put an end to costly payday loan extensions, the Consumer Financial Protection Bureau (CFPB) proposed a rule in June that would tighten qualification criteria and minimize fees incurred by borrowers. Says the CFPB: “The proposed rule would require lenders to determine whether borrowers can afford to pay back their loans. The proposed rule would also cut off repeated debit attempts that rack up fees and make it harder for consumers to get out of debt.” In essence, these new protections would radically transform the way payday lenders do business and pose serious threats to their bottom line.
Why the Shift Toward Installment Loans?
In early August the Wall Street Journal reported a 78% increase from 2014 to 2015 in the amount of money lent as installment loans to borrowers who had credit scores of 660 or less. Installment loans in 2015 amounted to a whopping $24.2 billion – nearly three times the amount lent in 2012, the article adds. Why the steep increase?
Simply put, payday lenders are hoping to dodge threats posed by the CFPB’s new regulations by replacing traditional payday loans with installment loans. Their defense is that installment loans minimize the need to file an extension, because the borrower can repay the loan over time. However, this doesn’t necessarily mean installment payday loans are a more affordable option for consumers.
Is the Installment Model Safer?
The CFPB may have had good intentions with these new proposed protections, but borrowers could face even more problems under the new model. “The prospect of harmful loans would persist, because the proposed rule would leave lenders free to charge any rate and set almost any term as long as they make a ’reasonable determination’ that the borrower can repay the loan,” says the Pew Charitable Trusts. And the higher the interest rate, the longer the principal sits untouched.
On average, payday loans are accompanied by an interest rate greater than 300%, according to the CFPB. Making it even worse, the borrower must also fork over loan origination and refinance fees, which are around 10% of the loan amount, notes the Wall Street Journal. Furthermore, borrowers may be afforded the luxury of a cheaper monthly payment, but the total amount remitted to satisfy the loan will be substantial because of the lengthier repayment period. To eradicate the issue, the Pew Charitable Trusts recommends that the CFPB modify proposed regulations to include “pro-consumer product safety standards, such as limiting loan payments to 5% of a borrower’s paycheck.”
The Bottom Line
Despite the CFPB’s efforts to curb abusive payday lending practices by proposing stricter screening requirements, cash-strapped borrowers may face even greater risks. While an installment loan buys more time by extending the repayment period, it’s also more costly, because payday lenders are still free to assess astronomical interest rates and these would extend over a longer period. (For more, see The Best Alternatives to Payday Loans and Beware of Guaranteed Payday Loan Websites.)