New Consumer Financial Protection Bureau Study Shows How Easy It Is For Cash-strapped Borrowers To Get drawn into a vehicle title loan debt trap.
Auto title loans share many of the same nefarious qualities that have made their cousin, the payday loan, such a popular target for regulators. Both products are powered by triple-digit interest rates (except in states where they are prohibited or have specific interest rate caps) and are issued regardless of the borrower’s ability to repay the loan. . While payday lenders use a borrower’s proof of income (like a paycheck stub) to secure their loan, auto title lenders use the borrower’s car as collateral.
Since the value of the title loan is based on the value of the car, title loans also tend to be much larger than the typical payday loan – $ 959 versus $ 392. On average, a title loan consumes half the salary of the average borrower, according to previous research from Pew Charitable Trusts. If the loan is not repaid, the lender has the right to take possession of the car.
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“The typical borrower can only afford [to pay back a loan that is] about 5% of their salary to make ends meet, ”says Nick Bourke, manager of Pew’s small dollar loan project.
CFPB data shows that a third of title loan borrowers default on their original loan and one in five borrowers have repossessed their car. Most securities loans must be repaid within 30 days.
About 80% of title loan borrowers take out another title loan after they have paid off their initial balance. Thirty days later, almost 90% borrow these loans again. Overall, more than half of all securities lending monitored by the CFPB resulted in at least three additional loans and one-third of all initiated loans resulted in seven or more loans.
So how do you solve a problem like securities lending? CFPB’s response so far has been to propose new rules that would require these lenders to strengthen their underwriting practices. The agency was due to release these new rules in early 2016, but has yet to do so. In the meantime, it also puts pressure on big banks and credit unions to help fill the void that will be left once payday and securities lenders are shut out of the market by stricter regulations. The idea is that traditional banks could offer small dollar loans at a relatively low interest rate to consumers in financial difficulty, providing them with a much-needed alternative.
The real problem here is not that title loans and payday loans exist. It is because the industry has not yet found a better alternative for consumers in financial difficulty.
There are reports that at least three major banks are testing a payday loan alternative, but for the most part, banks are biding their time until the CFPB’s new rules on small dollar loans are released. “If the CFPB sets the standards, you’ll see a lot more banks come into this market and provide loans that cost 6 times less than payday loans and title deeds cost,” says Bourke. “I don’t think you will see banks offering auto title loans, but you might see banks giving small cash loans to existing checking account customers.”
Currently, only 1 in 7 federal credit unions offer an alternative payday loan, according to the Pew Charitable Trusts. Their business is a drop in the ocean – 170,000 of these loans were issued by credit unions in 2014, compared to over 100 million total payday loans.
Plus, banks already have their own version of a small dollar loan – overdraft fees, which just happen to be a several billion dollars source of income. They don’t look like a payday loan, but they have a similar effect. Most of the time, the transactions that led to bank overdrafts are $ 24 or less and are refunded within 3 days, depending on past research by the CFPB. But the average bank will still charge that customer an overdraft fee of $ 34. This is actually an interest rate of 140% on a three day loan.
Most people who turn to payday loans or title loans are just trying to make ends meet, looking to pay their bills or pay their rent on time, Pew research has shown. In a call with reporters on Tuesday, the CFPB declined to give advice on where clients can turn to find other sources of emergency loans. The problem is, There are not a lot.
With stagnant wages and rising fixed costs, American households feel overwhelmed by daily expenses, let alone cover unforeseen expenses. Sixty-three percent of people said they wouldn’t have the money to cover a $ 500 auto repair or a $ 1,000 medical bill, according to a recent Bankrate poll.
Making small loans safer – but not impossible – to obtain seems to be the answer here. It’s a delicate balance for regulators. The rules for lenders need to be tough enough that low dollar lenders can’t take advantage of financially vulnerable people, but not so much that the entire industry is bankrupt.
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Mandi woodruff is a reporter for Yahoo Finance and host of Brown ambition, a weekly podcast on career, life and money.
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