Why Doing Away with Small-Dollar Loans is Not the Answer

Most Americans take access to credit for granted. A week doesn’t pass without spam mail advertising a new shiny credit card offering different perks and benefits. Recent estimates show that there were 364 million open credit card accounts in the United States as of the end of 2017, with about 7 in 10 Americans having at least one credit card. This isn’t surprising given that 80% of cards are owned by consumers with a credit score higher than 620. For consumers with poor credit histories and scores lower than 580, however, such credit options are not even on the table. About 12 million of these people turn to small-dollar credit services to make ends meet. Surprisingly, until recently, the federal government was threatening to take this option away from them.

The Consumer Financial Protection Bureau (CFPB) recently proposed to re-examine the small-dollar lending rules created under the Obama Administration in 2017, opening an opportunity to re-evaluate the role of small-dollar lenders, who are frequently vilified. The reason, according to the CFPB, is that there was “insufficient evidence” the proposed rule was protecting consumers and signs that it actually would decrease competition in the industry and reduce access to credit for consumers who use small-dollar and short-term loans, such as payday, single-payment vehicle title, and longer-term balloon payment loans.

The proposal for re-evaluation has been received with some loud criticism, as it opens to scrutiny a 1690-page document resulting from five years of research done by CFPB. While it’s understandable why the decision would be frustrating for some, here is why this decision is in the interest of the underserved and vulnerable consumers.

Millions of Americans don’t meet the requirements to get a credit card, and so they turn to small-dollar lenders. Many of those who use and need these services often don’t have access to traditional bank services, and so a small-dollar loan is an option to get cash quickly when emergencies arise, or even to cover basic living expenses.

The CFPB’s own report published in 2016 predicted that when the 2017 rule takes effect, “payday loan volume and revenues would decline between 60% and 82%.” This would translate to denying many of the most vulnerable consumers the only viable option to access credit.

95 percent of borrowers value having the option of having access to small-dollar credit services and believe that small-dollar loans provide a safety net during unexpected financial trouble. Losing access to credit is harmful to any consumer, regardless of their income. But what do you do when one of the few options to capital is taken away from you?

When you’re in a short-term pinch for cash, small-dollar loans are often a better and faster option than the available alternatives, such as overdrawing a bank account, defaulting on a different loan, or even resorting to illegal activities. All of these other options imply high implicit charges. For consumers with low credit scores, getting a loan from a bank is not even an option.

The demand for small-dollar loans won’t disappear, but the burden on vulnerable consumers would not decrease either. The burden goes beyond the sensibilities of the average consumer and can make life much harder in the long run. Imagine having to skip a doctor’s visit, bouncing a check for a utility bill or even rent, or not being able to provide your children’s next meal. These are all burdens that low-income consumers who rely on small-dollar loans frequently confront.

Although these vulnerable borrowers face short-term financial obligations, they do their research when deciding for a small-dollar loan by considering other credit options available to them. As a recent study shows, payday loan applicants, for example, had an average of five credit option inquiries during the 12 months before taking out a loan, three times higher than that of the general population.

The CFPB is right to be worried that the 2017 small-dollar rule would harm those who most need a hand up: low-income consumers. After all, it is the Bureau’s job to educate and protect ALL consumers.

Instead of focusing on how to limit specific options to access credit, the government should spend at least the same effort on promoting the development of new technologies that facilitate the development of products and services that improve financial access for the underserved consumers, as well as educating consumers on finance and budgeting.

It’s easy for most of us to take access to credit for granted and enjoy access to a multitude of credit options, but for the 12 million Americans that are not thinking about adding an Amazon or Apple credit card to their wallet, small-dollar loans are one of the few solutions available to invest, grow, and sometimes even survive.

This piece was published in Issues & Insight.

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