Why Online Payday Loans Need Regulation
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UPDATED: Aug 31, 2012
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According to the Pew Charitable Trusts the payday lending industry takes in at least $7.4 billion in revenue each year. Over 12 million borrowers take out payday loans annually.
Online payday loans are becoming the dominant form of payday lending. While physical retail lending stores are readily available in many cities and towns, they lack the national and global level of accessibility that online payday lending offers.
Unsurprisingly, the levels of regulation that apply to retail and online businesses are not the same. Retail payday lending stores, being tangible businesses, are fairly easy to police and regulate. In contrast to this, online payday loan companies, who often cross state and international borders, are far more difficult to regulate. This allows some online lenders to abuse and take advantage of borrowers through unethical practices.
The public’s lack of financial education only helps enable some of these unscrupulous lenders to take advantage of unsuspecting borrowers.
The average borrower may not be up to date on current payday loan industry developments. Even though consumers can inform themselves by seeking online payday loan quotes and information, current consumer awareness is lacking since lender websites do not always reveal the full cost of online payday loans.
Numerous states, counties, cities, and even towns have passed regulation that restricts retail payday lending stores. Some of this regulation governs permissible interest levels and required disclosures, while other laws restrict location and zoning requirements. At a federal level, the military and the federal government have even regulated the zoning of payday lenders near bases.
However, online lenders, who often require private bank account information from applicants, are largely unregulated. Nothing prevents borrowers, seduced with promises of inexpensive loans, from entering their banking information into websites. This has lead to ongoing problems caused by the online payday loan industry.
Similar to retail loans, online payday loans carry high interest rates. Online payday loans can cost up to $30 per $100 borrowed which equates to an annual interest rate (APR) of 650 percent.
Needless to say, these online cash advances can be a costly problem for borrowers.
Exacerbating the situation is the current slow economy which is still reeling from the effects of the recession. Many people are under financial duress and struggle to survive due to low income jobs, unemployment, and wiped out savings or investments.
On top of these economic woes, life often throws unforeseen circumstances at the most inopportune times. Unexpected and emergency expenses, such as necessary car repairs or medical bills after an injury, are all too common in life. In these trying situations, many borrowers are pressed to consider borrowing a loan. Unfortunately, online payday loans—often carrying triple-digit interest rates—can turn an already bad situation into a worse one.
Lenders do not always inform borrowers about their product’s sky-high interest rates. While retail lenders may be forced to do so through local legislation, the situation online is far different. The operational differences of online lenders compared to their retail counterparts allow opportunities for abuse.
Retail lending stores are under the oversight of local governments, such as city governments and Chambers of Commerce, whereas online operations are far more elusive. According to a report by the California Department of Corporations, online lenders often fail to notify prospective borrowers of the APRs that accompany their online payday loans. Federal and state law requires the disclosure of APRs since those numbers are viewed as a measurement of the true cost of many forms of financing, including online payday lending.
In addition to lack of disclosures, online payday loan lenders, by the very nature of online business operations, require applicant borrowers to submit personal financial data, such as bank account data. According to regulators, some unscrupulous lenders deposit funds into borrower accounts before the borrowers have even agreed to the loans and completed the borrowing process. Lenders then withdraw money from bank accounts for repayment, sometimes without notification to the borrower.
Naturally, this unethical practice has angered many borrowers, some of whom have closed bank accounts in an attempt to safeguard their money. Aggressive lenders have been known to pursue these borrowers in small-claims court.
Unfortunately, stealing money isn’t the only crime that some online lenders commit.
Equally worrisome for borrowers is the practice of certain online lenders not providing sufficient contact information. Even more heinous is the practice of certain lenders operating out of state and overseas in efforts to avoid licensing and government-mandated regulation. While banks and credit unions must obtain licensing and must follow stringent regulations in order to operate, unlicensed lenders are effectively illegal operations that leave little recourse for aggrieved borrowers.
Clearly online payday loan lending requires increased measures of regulatory controls.
Many activists propose to protect borrowers by limiting online payday loan amounts and lifetimes. This would effectively curtail the amount of debt that borrowers are responsible for as well as the amount of time that debt accrues.
While consumer protection advocates call for interest rate and online payday loan lifetime caps, these protections are difficult to enforce against online lenders who already flagrantly operate without certification and licenses. Furthermore, it is almost dismissive to simply tell borrowers to try other methods of obtaining money, such as borrowing from friends or family, when there is clearly a huge demand for payday loans.
Payday lending is not facing a national ban and may never face such legislation since the industry devotes such massive resources to lobbying efforts. A far more appropriate approach would be the implementation of regulation that protects borrowers who decide to use online payday loans.
By instilling regulation that would require banks to approve third-party access to bank accounts, we could prevent unlicensed lenders from making illegal withdrawals.
Specific online payday loan certification that covers operations nationwide may be another prudent form of regulation. Visible certification on websites can inform both prospective borrowers and banks that an online lender is reputable, upstanding, and worthy of access to borrowers’ bank accounts.
These proposed regulatory measures will involve the banking industry and may be opposed by various special interest groups. However, regulatory efforts involving two opposing factions are rarely universally welcomed with open arms. Developing and implementing regulation is a difficult endeavor, but just because something is difficult does not mean it should be avoided, nor does it mean that the borrowers of payday loans should be left to the mercy of unregulated internet business operations.