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America’s Mousetrap: Bringing an End to Predatory Lending

Overview:

We all need loans. Whether it be a couple bucks for a sandwich, or hundreds of thousands of dollars for a house, loans can come in handy. Loans have a history that stretches back thousands of years, as far back as the Bible. Unfortunately, in the last 200 years, we have seen the advent of predatory lending. Predatory lending occurs when a lender loans intentionally to poor people with the intention that that person will take longer to pay off the loan than expected, incurring additional interest and fees in the process. Because of this, low-income communities are three times more likely to receive a predatory loan(huduser.gov). When people take longer to pay off their loan, the lender collects more interest (US Consumer Financial Protection Bureau). In predatory lending, the interest rate or annual percentage rate (APR) is very high, so interest piles up fast on these loans. Two modern-day examples of predatory lending are payday lending and subprime auto lending. Both types use a similar tool to single out poor borrowers for the lender’s monetary gain: the credit score. I got interested in this topic while watching John Oliver, and because it related so well to my overall interest in the economy and it’s function, I knew this topic would be perfect to dive deeper into.

The Credit Score:

A credit score is a rating that shows how likely a person is to pay back a loan on time, based on how many lines of credit they maintain, how many loans they have paid off on time, and how much debt they owe (US Consumer Financial Protection Bureau). The credit score makes it very easy for predatory lenders to single out and go after people with low credit scores who are unlikely to pay back their loan on time. The lender can set a high APR on the loan because people with low credit scores cannot get a better loan anywhere else. This inequality between high and low credit scores causes a social and economic divide that cannot be broken until the problem of predatory lending is solved, because the process is recursive. Someone with a low credit score will continue to be offered bad loans and will end up not paying their loans on time because of the high interest rate. This failure will then contribute to their low credit score, and the cycle begins again.

The Two Sisters of Debt:

Payday Lending:

Payday lending is when someone needs money for an essential item like food or an unexpected cost like a flat tire, but does not have the money yet, and so takes out a small loan against their paycheck. The idea is that when one gets their next paycheck, they will quickly be able to pay the loan. 

This graph show how people who need to take out payday loans continue to rely on them to make it to their next paycheck. For example, 94% of people who take out 1 payday loan take out another within a month.

The brief lending period requires that payday lending agencies set an extremely high interest rate on the loan to profit off the loan.  Payday lending can be helpful, as it can provide quick necessary cash between paychecks. The problem comes when the borrower cannot pay the loan back quickly. When a loan has an interest rate of from 300%-1000% APR (Fitzpatrick 2), a borrower can end up paying a huge amount of money in the long run. For example, if a payday loan of 50$ goes unpaid for a year, one could end up paying anywhere from 150$-500$ for just a 50$ loan

Subprime Auto Lending:

Subprime auto lending is another modern form of predatory lending. Subprime auto lending is when the price of a car is loaned to a borrower at a very high interest rate, usually because the borrower has a lower credit score. Because the price range of the car is often very far beyond what the borrower is able to pay, the borrower must take out a long-term loan to slowly pay for the car. 

This graph shows the abundance and increasing volume of sub-prime loans as the years go on. This booming industry will continue to take advantage of low-income communities on a larger and larger scale each year.

These subprime loans can have APRs as high as 25%. When a loan extends over multiple years, the borrower can end up paying over double what the car was worth. But the biggest problem comes when a borrower cannot pay off the loan. When a borrower does not make a payment, the car can be reclaimed or remotely prevented from starting by the dealer. A reclaimed or remotely disabled car can mess up a person’s life by making them lose their job and method of transportation.

What can society do?

Auto Lending:

A simple solution to the problem of subprime auto lending is capping the interest rates for auto loans. In the past, however, some states have tried to remove interest-rate ceilings. New York acted in order “to lift or abolish ceilings on specific categories of loans” (Farnsworth 3) in 1980. I think a more effective solution would be to have a buffer period between when the borrower misses a payment and when the lender reclaims the car. This policy would allow the borrower to find another way of getting to work in that time, or to alert their boss that their car was being repossessed so the worker would not be fired on short notice.  Recently, the problem of remote interrupt devices was solved in a similar way when Senate Bill 5269 passed in 2015. It prohibited “any secured creditor from disabling a vehicle without first providing notice of the disabling to the debtor” (Chamness 3). This bill has been beneficial to borrowers, and it shows why my solution for car repossessions has merit.

Payday Lending:

The easiest and most upfront way to solve this problem is by capping interest rates. Despite the failure at a federal level to cap APR, eighteen states have capped 2-week loan interest at 36% (Kirsch 3). But that solution brings its own problems. For example, in those 18 states, a $100 two week payday loan would only yield the lender $1.38 (Kirsch 3), which is very little profit when weighed against the risk that the borrower does not pay the loan back. The way to offer enough payday loans to people while still keeping the interest percentage low is to have the government offer payday loans. The government can offer payday loans to many people at a low interest rate because the goal of the government, unlike a business, is not to make as much money as they can—but rather to help the people in the country live good lives. The government-issued loans would not put people in a cycle of debt, but rather give people the payday loan service they need at a fair and low price. The government can then use the interest money collected to help the disadvantaged communities that need payday loans offered in the first place

We Need Your Help!

What can you do?

Contact your lawmakers! Here in California, this is the contact information you will need:

Kamala Harris: (415) 981 – 9369, https://www.harris.senate.gov/contact/email

Dianne Feinstein:(415) 393-0707, https://www.feinstein.senate.gov/public/index.cfm/e-mail-me

This is an issue that needs to be fixed on a large scale, and there is no better way to bring about change than to bring awareness to the people that can help. Contact your senators and representatives to bring awareness to this non-mainstream issue.

Sources Cited and Bibliography:

https://docs.google.com/document/d/1Z2YNL91UdZjOtelyTFURgCj38NMB3DAJHCYpdWWkcVs/edit

What do you think can be done?:

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COMMENTS: 1
  1. April 28, 2020 by Kyong Pak

    Finn, nice work! Your interest and passion for economics comes through in your presentation, and you honed in on a specific, persistent problem. Your explanation of current predatory lending practices was clear and succinct. Your infographics were helpful in illustrating the rise of predatory lending in the last decade. I wonder about the history of predatory lending, and when/how it expanded to the degree we see today. Thank you for sharing your proposed response, and calling on your readers to action at the end.

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