Payday lending has recently been in the news more often than ever, especially with the recent passing of legislation that makes payday loans more difficult to obtain in some states while allowing them to thrive in others. Payday lending itself has been around since at least World War II and has been highly controversial since its inception. Here’s how payday loans got started and why it’s controversial.
Before the 1900s
A large market for consumer credit did not exist in the early 1900s. As a result, consumer credit suppliers began to emerge from the shadows. These small-scale financial businesses pioneered payday loans. From the shadows, these salary lenders, also known as “payday lenders,” popped up in towns around the United States. While charging exorbitant interest rates, some of these lenders’ shamed’ late payers by making their unpaid loans public. Extortion and threats of violence were also used in their attempts to collect debts.
Due to these predatory practices, local policymakers intervened to end questionable salary lending practices. They also started licensing money lenders to expand consumer credit availability. One of the changes was an exception to the usual usury interest rate cap for small loans. The original United States colonies had interest rates capped at around 6% per year. Additionally, the first Uniform Small Loan Law of 1916 allowed for up to 3.5% monthly interest on $300 or fewer loans. This statute was adopted by two-thirds of the states in the United States. But, several states allowed annualized interest rates of 18% to 42%.
The 1920’s and 30’s
While the great depression and its maladies persisted, Commercial banks began providing loans to individual consumers in the 1920s and 1930s. However, Applicants would still need references, collateral, and other forms of creditworthiness. Pawnbroking and wage loans continued as a result. Extending credit against a post-dated cheque grew in popularity due to the financial insecurity of the time.
A mass-market for consumer credit emerged by the middle of the 20th century. With it, a wide range of credit options was becoming available to consumers. In America, for example, the first credit cards were issued. Cheque guarantee cards were introduced in 1969. This assured lenders that they could still get their money even if the check bounced. However, the fundamental disadvantage of this type of borrowing is that the borrower has little influence over when the repayment will be made. As a result, by the 1980s and 1990s, cash chequing had lost favor as a method of borrowing.
The origins of what we now call payday loans may be traced back to the early 1980s and the Federal Depository Institutions Deregulation and Monetary Control Act of 1980, which deregulated interest rates. This allowed some lenders to evade state usury interest rules. Some state governments also permitted them to charge high-interest rates so as to offer fast and easy loans. These developments pave the way for the growth of state-licensed payday lending businesses.
The early 2000s saw enormous growth in payday loan lending, exacerbated by the global financial crisis of 2007-2008. Although the business was regulated, the legislation did not keep up with rapid technological advancements and the need for small loans.
The 2010s and the Debates Around Payday Loans
Many people began misusing payday loans during this time, and lenders were strongly criticized. As a result, several federal legislation was adopted to regulate the business. Notable is the Military Lending Act of 2006, which essentially capped payday loans issued to military personnel and their dependents at 36% APR. The Consumer Financial Protection Bureau (CFPB) was given special jurisdiction to oversee all payday lenders under the Dodd-Frank Reform and Consumer Protection Act.
After two failed attempts, the CFPB 2017 Rule barred lenders debiting borrowers’ accounts. It also included “mandated underwriting rules,” which forced lenders to assess borrowers’ ability to repay their loans before approving them.
However, two trade groups sued the CFPB in 2018, claiming that the 2017 CFPB Rule is unconstitutional and that the payment provisions are arbitrary.
On November 6, 2018, the court issued an order postponing the 2017 Rule’s compliance deadline until August 19, 2019.
But the CFPB released a new final rule in 2020; it removed the obligatory underwriting rules and other components. The 2020 Rule also reaffirmed the 2017 Rule’s “payment provisions,” restricting lenders from attempting to debit funds again after two failed efforts unless the customer consents to such withdrawals. The payment conditions also compel lenders to give consumers written notice before making withdrawing payment.
In August 2020, after the CFPB 2020 was released, the groups in an amended case filed in asserted that the entire 2017 Rule was illegal. They further claimed that ratifying the payment provisions without notice and comment on rulemaking in the 2020 Rule was insufficient to make those provisions effective and fix the 2017 Rule’s constitutional flaws.
Similarly, the National Association for Latino Community Asset Builders filed separate a lawsuit against the CFPB in October 2020, attempting to invalidate the 2020 Rule’s repeal of the required underwriting provisions. The group claims, among other things, that the no-underwriting lending feature is damaging to borrowers. However, none of these cases have been settled and the CFPB is set to release a new payday loan Rule.
Meanwhile, payday loans have been widely criticized for their exorbitant interest rates and associated problems. Customers could apply for many payday loans at once and repeatedly return to the same lender. Those who rolled over their loans from month to month would find themselves in huge debts. Payday lenders have also been criticized for fostering a debt cycle in their customers by leaving them with less money.
However, a study by the Center for Financial Research claimed that payday loans don’t yield huge profits. According to proponents of limited rules for payday loan businesses, most people who need payday loans have already exhausted all other options. As a result, if payday loans are not available, such customers may be forced to turn to illegal sources. However, opponents of payday loans argue that the history of borrowers turning to illegal sources of borrowing is unfounded.
The small-dollar credit landscape is evolving today. Several banks have expanded their duties by issuing “deposit advance” loans, which they did not previously do. An increasing number of these firms and fintech are now offering these services online, making small and payday loans more accessible and faster. However, some of these lenders create problems for state regulators since they often use the internet to evade state regulations.
States that Banned or Restricted Payday Loans
Payday lending is legal but regulated in 27 states, with nine others allowing limited short-term storefront lending. The remaining 13 and the District of Columbia forbid the practice. Generally, as shown below, 23 states and 3 United States territories have some form of restriction or ban the business.
|Banned by default||Connecticut – The states’ laws disallow the use of wages as collateral. Its small loan law, check casher law, and usury law has a 12% APR cap on all loans, serving as a blockage to payday loans.|
|Banned by default||West Virginia – Payday lending was never permitted in the state. For loans up to $2,000, all regulated lenders must adhere to the 31% APR loan cap.|
|Banned by default||Guam – The United states North pacific territory has no specific restriction. But the payday lending business is prohibited by default.|
|Banned by default||Puerto Rico – In the state, all lending is governed by state laws; there are no specific payday lending laws. However, the practice is prohibited in the state. According to its Finance Board, all small loans have a 25% APR cap.|
|1955||Georgia – The state’s Industrial Loan Act of 1955 prohibited payday lending by setting a state license and registration requirement and strict rate caps. The Georgia Payday Lending Act of 2004 enhanced the fines and punishments for payday lenders that broke the law.|
|1980||Massachusetts – a 1980 bank lending law, has been holding lenders to an interest cap that prohibits payday loans in the state.|
|1998||Pennslyvinia – the state banned payday lending with a 6% APR cap on small loans.|
|Washington, DC -The District of Columbia Legislature outlawed payday lending in the state for the first time in 1998, when it prohibited check cashers from providing post-dated checks, and then again in 2007 when it imposed a 24 % APR cap on small loans.|
|1999||Arkansas – The Arkansas Supreme Court ruled in the 1999 Check Cashers’ Act, which licensed and regulated check cashing and deferred presentment transactions as illegal. With that, it effectively ended payday lending.|
|Virgin Islands – The payday lending business is banned in the U.S. Virgin Islands. According to a statute passed in 2000, lenders cannot charge more than 26% APR. This law makes the payday lending business impossible in the state.|
|2001||North Carolina – the state was the first to ban payday lending in the 2000s. It subjected small-dollar loans to a 36% APR cap.|
|Vermont – on May of 2012, Vermont banned payday lending by subjecting it to consumer protection regulations. No other state had ever attempted something similar.|
|2002||Maryland – its joint Senate resolution in 2002 made payday lending illegal, it capped a 33% APR on all loans in the state.|
|2008||Ohio – Payday lending is legal in the state, but it comes with many restrictions. A law in 2008 capped APR at 28% and imposed a $500 restriction on payday loans. However, in 2018, the maximum loan amount changed to $1000.|
|2009||Virginia – Payday lending is legal in the state, with a 36% APR capped in 2009. However, the term ‘payday loans’ was changed to ‘short-term loans’ according to a new law in 2020. Max loan amount set to be less than $2500, loan terms, a minimum of 4 months and 24 months maximum.|
|New Hampshire – Payday lending is legal in the state, but many offers are scarce because the business is severely restricted. According to a 2009 legislation in the state, APR for payday loans is capped at 36%, minimum loan term of 7 days and 30 days maximum. There is also a $500 payday loan limit.|
|2010||Arizona – When the statute allowing payday lenders to operate in Arizona expired in July 2010, payday lending became extinct in Arizona. All lenders who seek to do business in the state must now comply with the 36 % APR small loan cap.|
|Montana – Payday lending is legal in Montana. However, it has one of the severe restrictions for Payday lending in the U.S. In Montana, a new law reinstated usury laws and capped APR at 36% for payday loans. It also limited the payday loan amount to $50 and $300. The minimum loan term is 14 days, while the maximum loan term is 31 days. Rollovers for the loan are also not allowed. As a result of these restrictions, the number of payday lenders in Montana has drastically decreased since 2010.|
|2013||New Jersey – Check cashers were barred from cashing or advancing money on a post-dated check under the Check Cashers Regulatory Act of 1993. This was reinforced by the 2013 state law, which prohibits payday lending and limits loans to 25% and 30% APR.|
|2014||New York – Several legislations passed in 2014 prohibited payday loans in person, over the phone, or online in New York. The state prohibits the cashing of post-dated checks. State statutes provide a small loan cap of 25% APR on all loans.|
|2016||South Dakota – For the first time in its history, the state restricted payday lending in 2016. APR for payday loans is capped at 36%, and there is a $500 limit on payday loans businesses can offer. However, minimum and maximum loan terms are not specified.|
|2017||New Mexico -A bill was passed in the state that established the first statutory rate cap on loans. The New Mexico Small Loan Act of 1955, the New Mexico Bank Installment Loan Act of 1959, and the Money, Interest, and Usury statute were all altered by this bill. The bill rendered payday lending in New Mexico both impossible and unprofitable, ending it.|
|2018||Colorado – A 2018 ballot initiative in the state amended Colorado’s Deferred Deposit Loan Act. This limited APR for small loans such as the payday loans to 36% and set the maximum payday loan amount to $500. It also set the minimum loan term to 6 months with no specified maximum loan term. As a result, while Payday lending is formally legal. It is restricted in Colorado.|
|2020||Nebraska – While payday lending is generally legal in the state, in a 2020 initiative, Nebraska, restricted the business. APR is capped at 36%, the maximum loan amount at $500, and a maximum loan term of 34 days. Loan rollovers are not allowed.|
|Oklahoma – The state’s Small lender Act was signed in 2019 but began operation in 2020, restricted payday lending. The Act established that small loans could not go above $1500, and all monthly interest charges were not more than 17%.|
|2021||Illinois – Payday lending is legal in the state. However, according to a law signed by the Governor in 2021, all payday loans are capped to an APR of 36% with a maximum loan amount of $1000.|