Protecting Borrowers from Predatory
Short-Term Loans
5 Policies that will make a difference
The Assets & Opportunity Network is a movement-oriented group of advocates, practitioners,
policymakers, and others nationwide working to expand the reach and deepen the impact of asset-based
strategies. Network members are on the frontlines of state and local policy advocacy, coalition-building and
service delivery. The Network is both a learning community and advocacy community; policy
recommendations and advocacy efforts are shaped by members’ experience delivering asset-building
services in communities across the country.
High-cost, small dollar loans1 are a serious concern for asset-building practitioners and advocates, and for
the families that Network members serve. For lower-income households that sometimes struggle to meet
basic needs, a small, short-term loan can seem like an attractive way to meet expenses when cash runs short.
However, new research from the Pew Charitable Trusts shows that these loans are not as small or as shortterm as consumers anticipate: in a year-long period, the average payday loan borrower is indebted for five
months, spending $520 in interest to repay a $375 loan.2 In fact, this same research finds that only 14 percent
of payday borrowers can afford to pay off the full balance of their loan within the standard two-week
period. The large majority is only able to afford payments of $100 per month, which covers the fees for
reborrowing but not paying off the principal.
As a result, families who take out payday loans spend hundreds of dollars to repay them, rather than the
one-time fee lenders advertise. These dollars could be used to support families’ day-to-day needs or save for
the future, but instead they are paid to renew a “short-term” loan an average of eight times. This cycle of
debt is a serious threat to low-income families’ financial security and a barrier to upward economic mobility.
Clients in the matched savings and financial education programs that many Assets & Opportunity Network
members offer are harmed by these loan products and often misled about their true costs.
The Consumer Financial Protection Bureau has the authority to protect consumers from unfair, deceptive
and abusive practices in the payday lending market through regulation and supervision.3 The leadership of
Assets & Opportunity Network recommends five policies that will ensure that consumers only receive
affordable loans that do not undermine borrowers’ financial security, and also provide lenders the
opportunity to innovate and create better, less expensive short-term loan products:
1
High-cost, small-dollar loans include payday loans (the most common type), bank payday or deposit advance loans, and
other products that feature a short (usually 2-week) term with a balloon payment and very high interest rate—often as
much as 400% APR.
2
Pew Charitable Trusts. “Payday Lending in America: Who Borrows, Where They Borrow, And Why.” August 2012. Available
at: http://www.pewstates.org/uploadedFiles/PCS_Assets/2012/Pew_Payday_Lending_Report.pdf.
3
Our recommendations focus on regulations that the Bureau should develop and implement, but we recognize that active
supervision is also necessary. There are many supervisory systems that would effectively ensure that lenders are in
compliance and are held accountable, from a national tracking system of all short-term small dollar loans, to a consumer
complaint-based system, to one of random audits of lenders. The Bureau should develop a supervisory framework for the
short-term small dollar loan market that will effectively and efficiently achieve its regulatory objectives.
1. The Bureau should establish an Ability to Repay standard
In January 2013, the Bureau published an Ability to Repay rule for mortgage lenders; it should follow suit
and establish an Ability to Repay rule for the short-term small dollar loan market. Currently, lenders in this
market—whether a store-front payday lender, bank or online-only lender—are not subject to any federal
underwriting standards. The Bureau should develop and implement underwriting standards that are
designed to ensure that borrowers only receive loans they can afford to repay. Lenders should have to verify
and document that a borrower can afford the loan based on criteria set by the Bureau.
2. The Bureau should establish a minimum loan term of 90 days
We recommend that the Bureau set a minimum 90-day term as a required standard for all short-term, small
dollar lenders. There are several precedents for establishing a longer minimum loan term than the current
industry-standard 14 days. For example, in Colorado, small dollar loans must allow installment repayments
over at least six months. Oregon and Ohio require a repayment period of at least is 31 days. The Federal
Deposit Insurance Corporation (FDIC) ran a pilot on affordable short-term, small dollar loans offered by
FDIC-insured financial institutions and found that 90 days was “the minimum time needed to repay a
small-dollar loan.”4 One outcome of the pilot program was FDIC’s recommendation that, in order to be
affordable to borrowers, short-term loans must have repayment terms of at least 90 days.
Establishing a minimum loan term is important because the shorter the repayment period is, the more likely
that the borrower will have to reborrow rather than pay back the loan in full. More than 80 percent of
payday loan borrowers cannot afford to repay the loan in full at the end of the initial two-week term; once
they take out a loan they effectively have no choice but to reborrow and enter a cycle of debt. Given that this
is true for the vast majority of borrowers, mandating a longer minimum loan term is appropriate. Such a
requirement should also address refinancing issues and prepayment penalties. Requiring a 90-day term is
one of the most important steps the Bureau can take to help consumers break the cycle of debt. However, if
the Bureau does not establish such a requirement, there are still steps it can take to break the cycle of debt.
For example, the Bureau could establishing a cap on the number of loans a borrower can have in any 12month period, establishing a cap on the total number of loans that a borrower can have outstanding at one
time, or requiring all loans to be fully amortizing with no balloon payments.
3. The Bureau should prohibit mandatory check holding and automatic bank withdrawals, particularly
for deposit-advance loans from banks
In the current market, many lenders require the borrower to provide a post-dated check or written
permission to automatically withdraw money from the borrower’s bank account (ACH holding). The
lenders cash the check or withdraw the money regardless of whether the borrower has money in the
account. Lenders should not be able to mandate that borrowers provide post-dated checks or repay through
ACH withdrawal. The current practice of mandatory check and ACH holding should be prohibited because
it prevents borrowers from being able to control their own bank accounts—a fundamental threat to their
financial security. Further, check and ACH holding can exacerbate financial instability by causing overdraft
and insufficient-funds fees that effectively increase the cost of borrowing. Prohibiting automatic bank
withdrawal is especially important for “bank payday” or deposit-advance loans; in these cases the financial
institution that made the loan has access to borrowers’ account balance information is knowingly triggering
additional fees.
4
“Template for Success: The FDIC’s Small-Dollar Loan Pilot Program.” FDIC Quarterly Vol. 4. No. 2 (2010). Available at:
http://www.fdic.gov/bank/analytical/quarterly/2010_vol4_2/FDIC_Quarterly_Vol4No2_SmallDollar.pdf.
4. Ensure that state restrictions on short-term, small-dollar loans are obeyed by online-only lenders
Many states have substantially limited or effectively banned traditional payday lending by instituting usury
caps, requiring installment payments, limiting reborrowing, and other measures. However, some lenders
that operate exclusively online continue to make loans to consumers in states where the loans are not legal.
These lenders have been able to circumvent state laws because they are licensed out-of-state in areas with
few restrictions on short-term, small dollar lending. This practice undermines consumers’ financial security
in all the same ways that traditional payday lending does, and additionally circumvents state laws intended
to protect a state’s citizens from predatory lending.
The Bureau should use its authority over this industry to ensure that consumers living in states that restrict
access to these loans are covered by the laws enacted in those states. Network members in states with
restrictive laws, including Maryland, Oregon and New York, were especially concerned about online
lenders “flooding” their areas and taking advantage of their residents, and strongly recommend that “online
payday lenders must be required to abide by state payday lending laws.”
5. The Bureau should support research and testing of alternative small dollar loans
In addition to restricting harmful loan features, the Bureau should use its powers to support the
development of small-dollar loan products that are consumer-friendly. As one Network member put it,
“having more affordable, responsible small dollar installment loans will do more to help people manage
short-term emergencies and break the cycle of debt.” Some lenders, particularly credit unions, technologydriven startups, and traditional financial institutions, are working in partnership with nonprofit service
providers to develop and test affordable consumer-friendly small-dollar loan products, but are concerned
about negative reactions from regulators, including the Bureau.
The Bureau can address these concerns and create space for innovation through supporting research and
evaluation of new or experimental short-term, small-dollar loan products. Such research is needed to
identify the mix of loan features that help borrowers improve their financial situation while remaining a
sustainable and even profitable product for lenders. The Bureau could then use this research to provide
guidance to lenders about what is acceptable and what is problematic when developing new small dollar
loan products. Thus, allowing lenders the ability to test and pilot new products with assurance that their
efforts meet the Bureau’s standards of consumer safety and affordability.