Tuesday, January 26, 2016

By Mike Poletika, Research Associate

House Bill 1340 is bad. Not just bad, but monstrously bad. Strong words, but the specifics of the new long term payday lending bill should send shivers down your spine. At a time when more than 1 in 3 Hoosiers lives below economic self-sufficiency, HB 1340 would allow a single payday loan to take up to 10% of the average borrower’s gross annual income, with a horrifying 320% APR. Just imagine the damage to low-income families and the drain on Indiana’s economy – terrifying!

If you’ve never been unfortunate enough to take out a payday loan, it works  by a borrower taking out a loan between $50 and $605 that is secured by a post-dated check or direct access to a bank account. Then, the borrower must repay the loan principal and finance charges on his or her next payday. With annual percentage rates (APR) up to 391%, payday loans often become debt traps, where borrowers receive a loan, repay on their next payday, and then do not have sufficient funds to make it until the following payday. To make ends meet, they take out another loan for the next payday. Rinse and repeat.

HB 1340 allows payday lenders to make a new type of small dollar loan that, in some ways, is actually more harmful to consumers than existing payday loans. Unlike the existing type of loan, which have balloon payments, long term small loans are repaid in installments. On the face of it, not all installment loans are bad. In fact, we support the installment loan structure in Senate Bill 99. However, the way in which interest is paid on the long term small loan in HB 1340 is frightening.

The bill allows lenders to charge 20% interest on the origination amount each month of the loan’s duration. Say a borrower received a $2,000 at origination (the highest borrowable amount), with equal loan repayments each month for a year. Each month a borrower would have to pay about $167 on the principal plus $400 in interest. Over the course of a year, the interest on a $2,000 payday loan adds up to $4,800, for a total of $6,800 owed. The APR on this type of loan is a whopping 320%, making this not a loan, but a trap.

Complicating matters, there is a protection that limits the repayable amount (the principal + interest) to 10% of the borrower’s annual gross income. So the typical payday loan borrower, whose annual gross income is $25,000, is limited to taking out a loan with a total repayment of $2,500. Of that $2,500 the borrower is only getting $735 loaned to them  but has to pay back $1,764 in interest on top. This means that over 70% of the total loan repayment is interest. Research from Pew shows that the typical borrower can only afford to use 5% of their income to make loan payments without having to borrow again.

While the structure of the interest payments is the most glaring problem with HB 1340, there several other features of the bill that have the potential to harm consumers. Currently, payday lenders can take borrowers to court to reclaim unrepaid debts. This bill attempts to allow lenders to seek attorney fees from the borrower if the lender wins the case. Because borrowers tend to be low income folks who cannot afford an attorney for small claims court, the scale is tilted toward the borrowers in nearly all of these cases. Having the ability to recover attorney fees also reduces the incentive to do thorough underwriting of the loan.

There may be an amendment that changes some of the key loan terms, yet still keeps the loan’s overall exploitative structure. Instead of capping the loan at $2,000, the amendment would set the upper borrowable amount at $1,000. The loan term would be reduced to six months, and the interest would be 10% on the origination amount. Even if this change was made by amendment, the APR is still horrifically high and a borrower would have to pay about $267 per month in interest and the principal, or $1,600 in total over the course of the loan.

Ultimately, borrowers who take out the loan product proposed in HB 1340 could face financial ruin, threatening a Hoosier economic recovery that is already slow in reaching many working families. The terms of HB 1340 are exploitative and the interest rates are usurious.  In order to protect Hoosier consumers, the Indiana Institute for Working Families calls on the General Assembly to defeat HB 1340 in committee.

Photo credit: "Payday loan shop window" by Gregory F. Maxwell <gmaxwell@gmail.com> PGP:0xB0413BFA - Own work (Original caption: “By Uploader”). Licensed under GFDL 1.2 via Commons goo.gl/LXkIX6


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