On the other side of the pond, there is a thriving payday loan industry that shares many features with its UK equivalent. There are also some differences. Arguably, the differences are even more important than the things that are the same. Comparing payday loans USA and the UK industry, we can learn important things about the way our short term loans are managed.
Short term loans USA: an introduction
In 2015, payday loans USA was a $46 billion industry.
Pew Charitable Trusts reports that 12 million people use payday loans each year in America. That equates to just over 3% of America’s population.
Payday loan customers have an average of $383 of short-term debt.
5.5% of all US adults have made use of payday loans over the previous half-decade.
69% of first-time borrowers were using the money to cover a regular outgoing, such as a utility bill or rent payment.
For comparison, the 2013 high-cost credit industry in the UK was worth £2.8 billion. Now, 1.6 million people were making use of short-term loans. Roughly 2.5% of the UK population were payday loan customers.
Short term loans USA: regulation
Perhaps the most important thing to recognise is that no two states are the same. Regulations can vary from one to another, meaning that the lending industry USA-wide is not as simple and clear-cut as ours.
Payday loans are fully legal in just 27 of the 50 US states.
The FCA and CFPB
In the UK we have the Financial Conduct Authority.
This is a regulatory body that authorises and monitors short term lending, to ensure that it is fair and responsible.
In the US, things are much more complicated. The Consumer Financial Protection Bureau is the FCA’s American equivalent but is much less involved in the process.
In the US, short term loans can be approved without an affordability assessment. Lenders can also make repeated attempts to collect payments, even when the money is not available.
The UK’s Financial Conduct Authority requires lenders to be sure that consumers can afford the loans they apply for. In the US, this is still not the case.
The CFPB has proposed rules to bring payday loan regulation more in line with the UK standard, but these rules have not yet been actioned. The intention is that they will apply to short-term loans up to 45 days and longer loans with an APR of 36% or more.
It is predicted that the new rules would reduce the US payday loan market by 84%.
In the UK loans without an affordability assessment are under strict scrutiny. In other words, credit organisation must carry on a full credit history check according to FCA regulations.
Payday Loans USA – State laws
Individual states have their own laws.
In 9 states, there are limits to how many short term loans one person can have at any time.
Lenders must search for applicants by name, to check that they are allowed another loan.
In Virginia and Washington, there are limits to how many loans a person can have over the course of a year.
Some state laws ensure that if a loan is renewed too many times, the interest rate must drop so that it can be more easily paid back.
In Washington, D.C., there is a maximum APR of 24% in place.
Strict rules in New Mexico
New Mexico is the state with the strictest payday loan laws.
There are caps on fees and total loan amounts.
Lenders must offer a 130-day repayment plan to any borrower that cannot pay back what they owe. There is also a 10 day wait period between one loan being repaid, and another being approved.
Fees are capped at $15.50 per $100 borrowed, over a maximum of 35 days. In contrast, UK price caps are set at 0.8% per day (or 80p per £100 borrowed), with a total maximum cost cap of 100%.
In New Mexico, payday loans cannot make up more than 25% of a consumer’s monthly income.
The Military Lending Act
The Military Lending Act specifies that payday loans must be capped at an APR of 36% for serving armed forces members.
It also ensures that no charges can be added as a penalty for early loan repayment.
Google’s payday loan USA ruling
In May 2016, Google announced a change that would affect the payday loan industry worldwide.
The changes came into effect in July 2016.
Google banned paid advertising for payday loans.
Normally lenders would still appear in organic (unpaid) Google search results. Yet now, their short term loans would no longer show in prominent paid-for positions.
Specifically, this ruling affects all loans with terms up to 60 days.
Google’s change allowed the largest and most well-known lenders to continue to appear prominently. They are the lenders most likely to hold the top search result positions.
Smaller and newer lenders can find themselves struggling to compete. As a result, they cannot gain prominence by paying for Google adverts.
Specifics for the lending industry USA
In the US, a further rule was added by Google. Included in this classification were all loans with an APR of 36% or higher.
The impact of Google’s payday loan ruling
Lenders, across the US and elsewhere, have been finding ways around the Google ruling. The landscape has changed, but not as much as some might have expected.
Brokers, for instance, can continue to pay for their adverts. Since they do not set their own lending terms, they can avoid restrictions by focusing on the lenders that stay within Google’s limits.
In the US, many payday loan brokers have added new information to their websites. They often state that loans should have APRs of no more than 36%, but that actual rates will vary.
Direct lenders are taking different approaches.
Some are using call-only adverts so that their APRs are not made visible through their Google adverts. They purchase a separate website, advertise ‘over the phone’ loans and then direct people to their usual loan offerings.
Others are setting up local listings on Google Maps, with companies that do not really exist. Customers attempt to contact the fake company, and are led on a journey that eventually takes them to the original lender.
Reduced transparency for borrowers
As regulators work to make the payday loan industry more transparent in the UK and US, Google’s ruling may be working against them.
It has encouraged some lenders, particularly in the US where APRs are taken into consideration, to mislead with their online advertising.
Consumers may feel less able to make educated decisions, when the lender that they are attempting to contact may be a front for a bigger provider.
Using a payday loan broker or comparison website may mean that borrowers are offered higher APRs. Higher than those originally suggested but will protect them from fake direct lenders.
Payday loans USA alternatives
In the UK, a credit union may be the closest payday loan alternative. Some consumers will get their loans from traditional banks or P2P lenders, though these are often for higher value borrowing.
Many people that need a low value, short term loan will instead use a credit card, though these can more easily lead to an unmanageable debt spiral
In the US, alternatives to payday loans include non-profit organisations. However, they offer loans with lower interest rates.
Many US companies provide the option for their workers to ask for immediate payment of earned money. Companies charge a fee for this service, but the employee benefits by not immediately getting into debt. If the money is spare, this is a valuable solution for an employee. If not, employees can be lining up problems for the future.
Debt spirals and traps
In the UK, we define a debt spiral as a situation where people are borrowing money to make repayments elsewhere. Usually resulting in them getting further and further into debt.
They can also apply to people that are not getting further into debt but need to rely on credit every month because they cannot build up a savings buffer.
The FCA limits the risk of debt spirals, by capping costs in many ways.
In the US, debt traps are not uncommon. The Center for Responsible Lending found that 76% of all payday loans were borrowed within two weeks of another being paid off. Borrowers are repaying their debts, then finding that they do not have enough money for their essentials.
Payday loans USA: summary
In the UK, the payday loan industry is relatively easy to understand.
The Financial Conduct Authority sets universal rules and price caps. All lenders must work within these rules, to keep their authorisation.
Maximum costs, when borrowing, can be easily calculated.
In the US, there are no universal rules. States have their own regulations, with some banning payday loans completely. Some US states have relaxed rules. Yet, others have requirements even stricter than the FCA’s regulations.
The Consumer Financial Protection Bureau intends to bring new regulations to the market. As a result, offering similar protections to those that are available throughout the UK.
For now, the experience of borrowing short term will continue to vary considerably across the US.