The Consumer Financial Protection Bureau's (CFPB) proposed regulations for payday lenders produced a strong reaction from the short-term loan industry.
Put them out of business, the industry warns, and people with lousy or no credit and no savings will have no place to turn when they need emergency cash.
It's true that these consumers have almost no options in an emergency. What can be debated, however, is if a vulnerable class of consumers is well served by loans for just two weeks at triple digit interest rates. Who, after all, can be expected to repay a loan in just two weeks if he or she doesn't have the money today?
"So often, people are forced into a situation to get a payday loan in order to survive between paychecks, and the payday lenders know the consumers will not be able to pay back the loan," said James Garvey, co-founder and CEO of the start-up Self Lender.
No credit card
The reason consumers go to a payday lender, more often than not, is they don't have a credit card. If they did, they could put the unexpected car repair bill on plastic and pay for it over a period of several months. They might pay 16% or more interest, but that would be a lot less than a payday loan that is due in two weeks.
The problem is that consumers with lousy credit can't get a credit card or any other type of unsecured loan. So Garvey believes the best course of action is to help people improve or establish credit.
Self Lender is an online source of credit builder loans which have been around for decades and are available from banks and credit unions. It isn't a quick fix, and consumers need a year to reap its benefits, but here's how it works:
A consumer with bad or no credit who works through a bank – or in this case Self Lender – takes out a loan for $1,000. But the consumer doesn't get access to the funds. The money goes into an interest-bearing CD.
For 12 months, the consumer makes payments of less than $100 a month on the loan. After 12 months, the loan has been repaid.
So what's the point, you might ask?
The point is that those 12 monthly payments are reported to the three credit agencies. If the consumer has no credit history, he or she does now – and if the payments have been made on time, that credit score should be pretty good. As a bonus, the consumer also has over $1,000 in savings.
With a decent credit score, the consumer's chances of getting a credit card are now pretty good. If the consumer is careful, only using the card for emergencies, he or she will have no need to take out a payday loan.
Garvey believes there is a huge market for this service. He says 20% of U.S. adults don't even have a credit score. Of the rest, he says half have subprime scores, making it difficult to obtain reasonably-priced credit.
"The majority of U.S. adults aren't able to take advantage of low interest rates if they need to borrow money," said Garvey. "Poor credit history can cost a person tens, if not hundreds of thousands of dollars in interest and fees over a lifetime."