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Payday Loans’ Potentially Predatory Replacement

As lenders respond to impending regulations by pushing different products, many fear that borrowers won’t be protected.

Elaine Thompson / AP

Dangerous, high-cost lending isn’t going away anytime soon.

While some have heralded the Consumer Financial Protection Bureau’s long-awaited payday-lending regulations as significant progress toward the end of predatory lending practices, other, similar products have, as predicted, started to take their place.

One of the biggest criticisms of the traditional payday-loan structure was that it required a large, lump-sum payment of principal plus interest. If—or more often, when—borrowers were unable to find the cash to pay back their very short-term loans with interest that reached the triple digits, these loans would be rolled into yet another short-term, lump-sum loan. And so the cycle went.

An uptick in what are called installment loans is the payday industry’s answer to that criticism—or, more precisely, the regulations that that criticism led to. Instead of making a lump-sum payment, installment-loan borrowers take out loans that are paid off a bit at a time, over a longer period of time. Installment loans are nothing new, and the same lenders who once predominantly peddled payday loans have been trying their hand at installment loans for some time, too. But now, they may try to make them a significantly larger share of their business. The Wall Street Journal recently reported that in 2015, lenders provided nearly $25 billion in installment loans to people with credit scores below 600. That’s 78 percent higher than the year before.

While installment loans can certainly be easier on borrowers than payday loans, they can also prove financially dubious. For starters, while repayment periods are longer, installment loans are still pretty pricey. Research from the Pew Charitable Trusts found that they often have monthly payments that exceed the 5-percent-of-income threshold that financial experts have deemed to separate affordable loans from unaffordable ones. Instead, these new loans often require borrowers to lay out between 7 percent and 12 percent of their monthly income on repayment. And while the spread-out payment system seems like a great solution, it can result in abuses too, Pew finds. Lenders can issue loans with extremely long repayment periods—for example, a $500 loan paid back over the course of a year—so that they can rack up more interest payments.

That means, in the end, that borrowers remain indebted for long periods of time and can wind up paying much more than they actually borrowed. (Sound familiar?) In such cases, it may not even matter to lenders if a borrower eventually defaults, since they would’ve already made a profit, notes a report from the National Consumer Law Center.

Looming federal regulations of payday loans will only accelerate the switch to installment loans, as lenders search for a way to make up lost revenue. While the CFPB’s payday lending rules include some regulation of installment products, they only focus on some of the more obviously pernicious terms: those that are open-ended, or allow lenders to access checking accounts or car titles in the event of nonpayment. Some fear that lenders will just toe the line, ensuring that loans don’t have the most egregious payday-like components—super-short payment periods and lump-sum payments—but will similarly target poor Americans and charge them high rates.

Keeping borrowers protected amidst these constantly morphing products will remain difficult. Since the federal government can’t cap interest rates, it’s up to states to set limits on how much interest is too much. And right now, laws related to interest rates vary significantly, with some states setting caps at 36 percent, some higher, and some without a cap at all. That makes the prospects for protecting consumers fairly daunting.