Payday Loan History

Payday lending has recently been in the news more often than ever, especially with the recent passing of legislation that makes payday loans more difficult to obtain in some states while allowing them to thrive in others. Payday lending itself has been around since at least World War II and has been highly controversial since its inception. Here’s how payday loans got started and why it’s controversial.

Before the 1900s

A large market for consumer credit did not exist in the early 1900s. As a result, consumer credit suppliers began to emerge from the shadows. These small-scale financial businesses pioneered payday loans. From the shadows, these salary lenders, also known as “payday lenders,” popped up in towns around the United States. While charging exorbitant interest rates, some of these lenders’ shamed’ late payers by making their unpaid loans public. Extortion and threats of violence were also used in their attempts to collect debts.

Due to these predatory practices, local policymakers intervened to end questionable salary lending practices. They also started licensing money lenders to expand consumer credit availability. One of the changes was an exception to the usual usury interest rate cap for small loans. The original United States colonies had interest rates capped at around 6% per year. Additionally, the first Uniform Small Loan Law of 1916 allowed for up to 3.5% monthly interest on $300 or fewer loans. This statute was adopted by two-thirds of the states in the United States. But, several states allowed annualized interest rates of 18% to 42%.

The 1920’s and 30’s

While the great depression and its maladies persisted, Commercial banks began providing loans to individual consumers in the 1920s and 1930s. However, Applicants would still need references, collateral, and other forms of creditworthiness.  Pawnbroking and wage loans continued as a result. Extending credit against a post-dated cheque grew in popularity due to the financial insecurity of the time.

Mid-20th century

A mass-market for consumer credit emerged by the middle of the 20th century. With it, a wide range of credit options was becoming available to consumers. In America, for example, the first credit cards were issued. Cheque guarantee cards were introduced in 1969. This assured lenders that they could still get their money even if the check bounced. However, the fundamental disadvantage of this type of borrowing is that the borrower has little influence over when the repayment will be made. As a result, by the 1980s and 1990s, cash chequing had lost favor as a method of borrowing. 

The 1980’s

The origins of what we now call payday loans may be traced back to the early 1980s and the Federal Depository Institutions Deregulation and Monetary Control Act of 1980, which deregulated interest rates. This allowed some lenders to evade state usury interest rules. Some state governments also permitted them to charge high-interest rates so as to offer fast and easy loans. These developments pave the way for the growth of state-licensed payday lending businesses. 

The 2000’s

The early 2000s saw enormous growth in payday loan lending, exacerbated by the global financial crisis of 2007-2008. Although the business was regulated, the legislation did not keep up with rapid technological advancements and the need for small loans.

The 2010s and the Debates Around Payday Loans

Many people began misusing payday loans during this time, and lenders were strongly criticized. As a result, several federal legislation was adopted to regulate the business. Notable is the Military Lending Act of 2006, which essentially capped payday loans issued to military personnel and their dependents at 36% APR. The Consumer Financial Protection Bureau (CFPB) was given special jurisdiction to oversee all payday lenders under the Dodd-Frank Reform and Consumer Protection Act.

After two failed attempts, the CFPB 2017 Rule barred lenders debiting borrowers’ accounts. It also included “mandated underwriting rules,” which forced lenders to assess borrowers’ ability to repay their loans before approving them.

However, two trade groups sued the CFPB in 2018, claiming that the 2017 CFPB Rule is unconstitutional and that the payment provisions are arbitrary.

On November 6, 2018, the court issued an order postponing the 2017 Rule’s compliance deadline until August 19, 2019.

But the CFPB released a new final rule in 2020; it removed the obligatory underwriting rules and other components. The 2020 Rule also reaffirmed the 2017 Rule’s “payment provisions,” restricting lenders from attempting to debit funds again after two failed efforts unless the customer consents to such withdrawals. The payment conditions also compel lenders to give consumers written notice before making withdrawing payment.

In August 2020, after the CFPB 2020 was released, the groups in an amended case filed in asserted that the entire 2017 Rule was illegal. They further claimed that ratifying the payment provisions without notice and comment on rulemaking in the 2020 Rule was insufficient to make those provisions effective and fix the 2017 Rule’s constitutional flaws.

Similarly, the National Association for Latino Community Asset Builders filed separate a lawsuit against the CFPB in October 2020, attempting to invalidate the 2020 Rule’s repeal of the required underwriting provisions. The group claims, among other things, that the no-underwriting lending feature is damaging to borrowers. However, none of these cases have been settled and the CFPB is set to release a new payday loan Rule.

Meanwhile, payday loans have been widely criticized for their exorbitant interest rates and associated problems. Customers could apply for many payday loans at once and repeatedly return to the same lender. Those who rolled over their loans from month to month would find themselves in huge debts. Payday lenders have also been criticized for fostering a debt cycle in their customers by leaving them with less money.

However, a study by the Center for Financial Research claimed that payday loans don’t yield huge profits. According to proponents of limited rules for payday loan businesses, most people who need payday loans have already exhausted all other options. As a result, if payday loans are not available, such customers may be forced to turn to illegal sources. However, opponents of payday loans argue that the history of borrowers turning to illegal sources of borrowing is unfounded.

Present-Days

The small-dollar credit landscape is evolving today. Several banks have expanded their duties by issuing “deposit advance” loans, which they did not previously do. An increasing number of these firms and fintech are now offering these services online, making small and payday loans more accessible and faster. However, some of these lenders create problems for state regulators since they often use the internet to evade state regulations.

States that Banned or Restricted Payday Loans

Payday lending is legal but regulated in 27 states, with nine others allowing limited short-term storefront lending. The remaining 13 and the District of Columbia forbid the practice. Generally, as shown below, 23 states and 3 United States territories have some form of restriction or ban the business.