NEW YORK (AP) — The lenders who advance poor people money on their paychecks charge exorbitant interest rates that often snare the most vulnerable customers in a cycle of debt, the industry's critics have long said.
Yet even consumer advocates who loathe the industry admit it fulfills a need: Providing small amounts of cash quickly to people who can't qualify for credit cards or a bank loan. Roughly 12 million Americans take out a payday loan each year, spending more than $7 billion, according to the Pew Charitable Trusts .
But with proposed new regulations from the Consumer Financial Protection Bureau predicted to cut deeply into the industry, experts and consumer advocates are trying to figure out what will replace it.
The traditional payday loan model works like this. A customer will borrow money, often at a retail payday loan store, where the borrower provides a post-dated check or gives written authorization for the lender to debit their checking account on a certain date, usually 14 to 30 days from the date the loan was taken out. Unlike an installment loan, where the loan is paid back over a period of months, a payday loan is due in its entirety when it comes due.
The problem with this structure is that the majority of payday loans are renewed or extended, critics say, which means a customer cannot come up with the full sum to pay off the loans and must re-borrow the loan for a fee. Roughly 60 percent of all loans are renewed at least once, and 22 percent of all loans are renewed at least seven times, according to a 2014 study by the CFPB . In California, the largest payday loan market, repeat borrowers made up 83 percent of loan volume last year , according to a state regulator's study released Wednesday.
The CFPB's proposal is not expected to take effect until early next year, and experts don't think it will change substantially from its current version. It would require payday lenders to determine each customer's ability to repay that loan in the time allotted and would limit the amount of times a customer could renew the loan. The CFPB's proposal represents an existential threat to payday lending industry as it currently stands, industry officials and regulators say, with loan originations projected to drop between 59 percent to 80 percent. While most of that drop the CFPB says would stem from the cap on loans being renewed, the CFPB acknowledges in its proposal the volume of payday lending would decrease under the new regulations.
"Frankly, there will be fewer small dollar loans available to consumers because of this proposal. There will not be a one-to-one replacement. And anything that does replace it will be an inferior product," said Bob DeYoung, a professor of financial markets at the University of Kansas.
The industry has historically shifted quickly from one product to the next to escape regulation. When Arizona voters banned traditional payday lending in 2010, payday lending storefronts quickly converted into auto title loan shops - offering the same high interest loans structured differently. Other payday lenders moved onto Indian reservations to escape state regulations, or set up shop in countries outside the U.S. as online-only payday lenders.
But these regulations, the first nationwide clampdown on payday lending, would cause thousands payday lending stores to close nationwide.
"This proposal doesn't tweak or reform an existing product. This is a complete overhaul of the industry," said Jamie Fuller, senior vice president of public affairs of Advance America, a payday lending chain.
What would replace payday lending is not an easy question to answer, but there are a few scenarios industry experts and consumer advocates expect could happen.
SAME BIRD, NEW FEATHERS: The simplest answer is the industry will survive, and keep doing what it is doing by changing the nature of the loans it provides.
Nick Bourke, a researcher at Pew who has spent more than five years looking at the payday lending industry, says the industry is already making adjustments in the wake of new regulations. When Colorado effectively banned traditional payday lending, the industry moved into high cost installment loans that are paid over a few months instead of all upfront in a few weeks.
"There will be fewer two-week payday loans because of the CFPB rules, but the industry has already shifted to installment lending that is paid over several months. There will still be high interest rate payday loans on the market," Bourke said.
PAWNING: Another possible beneficiary may be pawnshops. A 2015 Cornell University study found that states that banned payday loans saw more activity at pawn shops and more checking accounts being closed involuntarily, possibility due to an increased amount of people over-drafting their accounts. But pawn shops are largely seen as a place for people to borrow who don't have checking accounts.
BANKS TAKE OVER: Consumer advocates and the CFPB have been quite public in saying the best solution would be for traditional banks, which are highly regulated, to take over payday lending. Banks have plenty of locations, easy access to funds, and can make loans at much lower interest rates and still be profitable. But banks have been cool at best to the idea. Payday loans are seen as a risky and expensive. The costs for underwriting and processing them would eat into profits from the high interest rates they carry.
"Most of our members are willing to do small dollar loans, but they are not very profitable. Application fees don't cover the cost of doing the application and the processing and the credit check. There are just fixed costs that you just cannot get around," said Joe Gormley, assistant vice president and regulatory counsel at the Independent Community Bankers of America, a lobby group for small banks.
CREDIT UNIONS: There are already some experimental alternatives going on to replace payday loans.
One program run through credit unions is called the Payday Alternative Loan, where a customer can borrow between $200 to $1,000 at 28 percent interest and an application fee of $20. But interest in the program has been limited. The federal regulator for the PAL program estimates only 20 percent of credit unions provided such loans and loan originations were only $123.3 million last year, a drop in the bucket compared to the roughly $7 billion the mainstream payday lending industry did in the same year.
There's also a program being tried in Atlanta, run by the credit agency Equifax and the National Federation of Community Development Credit Unions, that will provide payday loan alternatives that would come with lower interest rates as well as financial counseling to help people avoid borrowing in an emergency again.
An earlier version of this story had an incorrect name. It is Nick Bourke from Pew, not Nate Bourke.
Ken Sweet covers banking and consumer financial issues for The Associated Press. Follow him on twitter at @kensweet.