Predatory lending is a $25 billion problem that perpetuates poverty and the socioeconomic victimization of many Americans.
Payday loans specifically ― which are inherently predatory ― cost borrowers between $2.6 billion and $3.5 billion in fees annually.
Although the payday loan industry is dominated by brick and mortar lenders, online lenders are an emerging player in the space. Approximately 70% of these online lenders operate without state licenses and use practices that are far more abusive, aggressive, and criminal.
This post details everything you need to know about predatory online payday lending, plus how to identify and avoid it.
What is predatory lending?
Predatory lending is the practice of lending money while imposing deceptive, unfair or abusive loan terms on a borrower. Predatory loans lead the borrower into a transaction that is not what they expected. As a result, borrowers end up with excessive fees, high interest rates, and obscure penalty charges.
According to The Pew Charitable Trusts, those with some or no college education are 82 percent more likely to use a predatory loan than those with at least a 4-year degree. Suggesting that payday loan borrowers lack the educational background to decipher loan agreements and compare rates amongst prospective lenders and loan options. And when you’re desperate for cash today, you may not care about what it might cost you tomorrow.
Predatory lenders capitalize on this and target consumers who believe they have few lending alternatives. The result is a seemingless never ending cycle of debt that ruins the already crippled financial health of the borrower by trapping them into a loan obligation that was never designed to be repaid.
What is an example of predatory online lending?
An example of online predatory payday lending is offering a repayment plan that automatically withdraws the rollover (or refinance) fee only while tacking on an additional 10% interest rather than a payment that would reduce the principal. This likely won’t be verbalized but instead be stated as a clause within the contract of the loan agreement. Furthermore, for a borrower to pay more towards the principal, they have to request a change by phone to the lender.
In a 2014 Pew survey, they discovered a case where on a $500 loan from online lender Castle Payday, operated by Red Rock Tribal Lending, the first five installments totaling $875 did not pay down any principal, and the borrower still owed the full $500 balance.
Five signs of predatory payday lending include:
- In-your-face advertising of fast cash now
- Hidden fees
- Promises of no credit check
- Access to your bank account is required
- The lender has a shady reputation or no reputation to begin with
What’s the difference between a storefront lender and an online lender?
Differences can include products offered, states of operation, and whether the lender is online only or has a storefront. While most of us can agree that payday loans can be bad news, not all payday lenders are equal. Some do their absolute best to operate within legal bounds of state law, while others act with complete disregard for state law or the borrower’s financial health.
Storefront payday lenders
Obviously, the primary difference is that storefront lenders make use of brick and mortar locations to conduct business. Storefront lenders often offer the borrower more transparency into expectations for repaying the loan. This is because many storefront payday lenders also offer services like check cashing or money orders and thus have a more intimate relationship with their customers. An applicant can speak with a live person at the kiosk to ask any questions that they may have about their loan agreement before pulling the trigger.
Storefront lenders typically make use of post-dated checks as securities for the loan rather than using an Automated Clearing House (ACH) network to make payment withdrawals directly from a customer’s bank account. Making the amount that’s going to be debited from a borrower’s account much more transparent. However in recent years, many storefront lenders have adopted ACH networks.
Though a substantial amount of payday loans acquired by storefront lenders are still regarded as predatory loans, their online counterparts are much more likely to participate in activities such as unauthorized withdrawals, aggressive debt collection tactics, and selling borrowers’ personal information.
Online payday lenders
Conversely, online payday lenders operate solely online to conduct business transactions ― which is the genesis of many potential problems for the borrower. Online lenders rely only on ACH networks to collect payments. Having access to a borrower’s bank account means that they can make as many withdrawal attempts as they please in an attempt to recoup their money and fees. According to a Pew report, 46% of online borrowers experienced withdrawals that overdrew their checking accounts, which is twice the rate of storefront borrowers.
In addition to overdraft fees, online borrowers are subject to other financial and privacy threats. Such as:
- Personal or financial information being sold to third parties without their knowledge
- Unauthorized withdrawals in connection with an online payday loan
- Closing their bank account or having one closed by their bank in connection with an online payday loan
Online payday lending is very much still the wild west
Only one in three payday loans are administered online, however, online lending’s market share is rapidly increasing. Online lenders’ revenue tripled from 2006 to 2013, from $1.4 billion to $4.1 billion respectively. If the growth rate’s trend continues at %27.6, then the industry could theoretically reach $28.7 billion by the year 2021. However, according to IBISWorld’s report, payday loans are a $12.1 billion industry so that is realistically the ceiling at which online lenders’ revenue could hit. But no matter how you skin the cat, online lending is a trend that’s growing expeditiously.
Maryland is a state that has effectively outlawed payday lending by capping the interest rate on loans at 36%. However, that doesn’t stop someone from googling “payday loans” online and submitting an application to an online lender who blatantly disregards state law. One Maryland borrower found himself in $2,000+ worth of payday loan debt, all from online lenders. And although these loans are incredibly likely to be illegal, that doesn’t stop these lenders from administering the loans and then auto-drafting the account every two weeks just to collect rollover fees.
It’s no wonder that despite only accounting for about one-third of the market, 9 in 10 payday loan complaints to the Better Business Bureau are made against online lenders.
A typical storefront payday loan costs $15 per $100 borrowed resulting in about 300% annual percentage rate (APR) for the borrower. However, the average online payday loan costs $25 per $100 borrowed ― or about 650% APR. Loans with APRs this astronomically high were never designed to be repaid. These types of loans are designed to trap people who have very limited credit options into long term debt cycles that result in bankruptcy.
Some states have attempted to fight back against these types of predatory online payday loans but state-level enforcement is often difficult because the lenders are incorporated in other states or offshore, or claim immunity based on an affiliation with Native American Tribes.
Are online payday loans legal?
Yes. Well… sort of. Depending on the state you live, payday loans can either be legal, illegal, or reside in the grey area of legality. It doesn’t matter whether you found the loan online or down the street. If payday loans are illegal in your state, then online payday loans are also illegal in your state.
Defined by Pew, there are three categories of payday lending legality by state:
- Permissive: All single-repayment loans with APRs of 391 percent or higher
- Hybrid: Have payday loan storefronts, but maintain more exacting requirements, such as lower limits on fees or loan usage, or longer repayment periods
- Restrictive: Have no payday loan storefronts
For additional information on the legality of payday loans, visit paydayloaninfo.org for the legal status of loans by state.
What interest rate is predatory lending?
The answer very much depends on the context. In the context of payday loans, which are defined as short-term, high interest loans that are usually due on a borrower’s next paycheck, the answer appears to be 36% APR ― the typical rate cap for restrictive states. Though this is still up for debate across the board.
How can I get out of a predatory payday loan?
1. Report the lender
First of all, report the lender. You can do this by submitting a complaint to both the Better Business Bureau and the Consumer Financial Protection Bureau. Additionally, file a complaint with your state’s banking office, which you can also find on the CFPB site. If you can prove that the lender deliberately lied to or deceived you about a payday loan, you can report it to the Federal Trade Commission for fraud as well.
2. Negotiate with your lender
We touched on this subject in a previous blog post about the repercussions of not repaying a payday loan. If you don’t have the money to repay the loan, say so. If you are facing bankruptcy, say so. Begin negotiations at 50% of the outstanding balance of the loan and work your way towards an agreement from there. Negotiations can be tricky, but the lender wants to recoup as much of their money as possible. This won’t happen if the debt goes to collections or if you file for bankruptcy, so they may be willing to work with you.
3. Consider Debt Consolidation
There are several different ways to consolidate payday loans. Though many who find themselves in these situations have limited credit options and traditional debt consolidation tactics just simply aren’t feasible. However, you do have options if you still have access to other forms of credit.
- Taking out a personal loan
- Drawing from a home equity loan or home equity line of credit
- Moving the debts to a balance transfer credit card
4. Payday Alternative Loans (PALs)
Payday Alternative Loans are loans administered by a federal credit union and can only charge up to 28% interest on the loan. Application fees max out at $20.
Additional consumer protection features of PALs include:
- Loan amounts are restricted between $200 and $1,000
- The borrower must be a member for at least one month
- Loan terms of 1 to 6 months
- A loan cannot be rolled over
To learn more about PALs and how they can help, visit the National Credit Union Administration’s website.
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