How High-Interest Loans to Desperate People Built a $90 Billion Industry

During the recent government shutdown, U.S. Secretary of Commerce Wilbur Ross wondered aloud why financially stressed federal workers didn’t just “get a loan.”

A wealthy private equity investor, Ross faced excoriation. But the underlying question remains, even with a second shutdown less likely to occur. For Americans with limited options and desperate for cash, this is where consumer lenders such as Enova International Inc., Curo Group Holdings Corp. and Elevate Credit Inc. step in.

They’re part of a growing industry of online companies which specialize in risky borrowers. Enova, for example, offers loans with interest rates ranging from 34 to 450 percent, depending on the amount, date of maturity and borrower’s credit score, according to its website. The expectation for the priciest kind of short-term borrowing, the “payday loan” of storefront fame, is that you will pay it back when your paycheck clears. Still, one could be forgiven for wondering how such sky high rates exist at all.

“Having no access to credit is worse for consumers,” said Mary Jackson, chief executive of the Online Lenders Alliance, a lobbying group that represents fintech lenders. She said high interest, high-risk loans have a widely known parallel—the bridge loan—which struggling homebuyers sometimes use to close a deal. “Most of these loans would be considered bridge loans—for major car repairs and plumbing leaks.”

And forget about the obvious Hollywood images that triple-digit interest rates bring to mind. The average customer isn’t an unemployed. recidivist gambler down on his luck. According to Jackson, they’re often college-educated thirtysomethings who are gainfully employed. But no matter what a borrower’s background is, critics warn that the price to be paid for such loans can get very high, very fast.

“Right now, 80 percent of payday loans are taken out within two weeks of a previous payday loan.”

About 12 million Americans use these high interest loans every year, both online and through about 16,000 storefront offices, said Alex Horowitz, a senior research officer with Pew Charitable Trust’s consumer finance project. In fact, U.S. consumers borrow almost $90 billion every year in short-term, small-dollar loans that typically range from $300 to $5,000, according to a 2018 report from the Office of the Comptroller of the Currency (OCC).

And the future is looking even brighter. Just last week, the industry received a boost by Kathleen Kraninger, a Trump administration budget official who recently took over the U.S. Consumer Financial Protection Bureau. She proposed the elimination of an Obama era requirement—set to take effect Aug. 19—that would have forced payday lenders to assess a borrower’s ability to repay. Consumer advocates were outraged by Kraninger’s proposal.

“Both borrowers and responsible lenders would suffer if the CFPB were to finalize the proposal,” said Pew’s Horowitz. The new rule would eliminate “well-balanced consumer protections and deregulate 400 percent interest loans issued to millions of struggling Americans.”

Though the industry is largely regulated by the states—only 34 even allow payday loans—a lawyer for some of the bigger lenders warned that the Obama rule would wipe out a significant portion of the payday industry. Alan Kaplinsky, a partner at the law firm Ballard Spahr, said the requirement that lenders make sure borrowers can repay “would have made it easier for offshore payday lenders to do business and charge consumers a lot more.”

But even with the CFPB proposal and a friendly U.S. administration, some online lenders are moving away from payday loans. Many have pivoted toward installment loans, which are paid back over time rather than in a single payment. Additionally, these lenders also offer what they call “lines of credit,” which operate in a fashion similar to credit cards.

Still, even installment loans can come with eye-popping interest rates. One example on Enova’s website shows a $1,000 loan with 13 payments at a 172.98 percent annual percentage rate (APR). In the end, this would require a total of $2,225.18 to pay off. Enova declined to comment.

The industry argues that high interest rates are needed to counter the risk associated with giving money to consumers more likely to default. In a securities filing last year, Chicago-based Enova spelled out just how risky its business can be.

For the third quarter of 2018, the company projected that close to 33 percent of its “short-term loans” balance outstanding would never be repaid. The expected loss dropped to about 19 percent and 13 percent for line-of-credit and installment loans, respectively. For context, banks only saw a 3.5 percent loss on credit card loans over the same quarter, according to the Federal Reserve Bank of St. Louis.

While such exorbitant rates might be justifiable to lenders, Horowitz said the cost to borrowers could be grave.

“Right now, 80 percent of payday loans are taken out within two weeks of a previous payday loan because the loans on average take up one-third of the borrower’s next paycheck,” he said, a burden that can grow with each new loan. “The average payday loan customer pays $520 a year in fees to repeatedly borrow $325 in credit.”

“Banks can be profitable at a price point six to eight times lower than average payday loan pricing.”

While in the short-run these lenders might have the upper hand, the days of super high-interest loans may be numbered. The payday loan industry sprang up because traditional banks were reluctant to serve the low credit score universe. This was in part because regulators didn’t give them clear guidelines. But that may be changing.

In 2017, another CFPB rule opened the door for banks and credit unions to offer small installment loans at reasonable prices. Last May, the OCC followed up with guidance for short-term, small-dollar installment lending. Then in November, the Federal Deposit Insurance Corp. issued a request for public comment on small-dollar credit products.

Horowitz sees this evolution as a great benefit to Americans who use payday products.

“Banks can be profitable at a price-point six to eight times lower than average payday loan pricing,” he said. For example, a payday borrower accumulates $350 in fees on a $400 loan in just over three months. At USBank, under its new “Simple Loan” product launched in September, a similar loan offered to a similar customer goes for just $48.

“It’s a really good thing that some of the banks are getting into small-dollar lending,” said Kaplinsky, the industry lawyer. “That will create more competition and ultimately help interest rates come down for consumers.”