A new report has found a dramatic decrease in Californians’ reliance on payday loans as a direct result of pandemic-related government assistance, including unemployment benefits, rent relief, eviction moratoriums, stimulus checks and loan forbearance. But experts warn that the use of payday loans is expected to rebound once government assistance ends.
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Pandemic government aid may have helped some Californians avoid using expensive payday loans last year, but some experts say it may be too early for celebration.
A new report found that in 2020, California saw a 40% drop in payday loans taken out compared to 2019, a drop equivalent to $1.1 billion. Nearly half a million fewer people did not rely on payday loans, a 30% drop from 2019.
Despite unprecedented job loss triggered by the pandemic last year, government-funded financial relief was enough to have an acute impact on the payday loan industry, according to the California Department of Financial Protection and Innovation. The new State Department released the report last week as part of its ongoing efforts to regulate and oversee consumer financial products.
the report comes on the heels of California’s new $262.6 billion budget, with multiple programs aimed at reducing economic inequality within the state. An unprecedented $11.9 billion will be spent on Golden State Stimulus payments, a one-time benefit that is not expected to continue for years to come.
“With these benefits gone, we expect a potential increase (in payday loans),” department spokeswoman Maria Luisa Cesar said.
Only temporary relief
Industry officials, state regulators and consumer advocates agree: Government assistance has helped Californians avoid dependence on payday loans – short-term, high-interest loans which must be repaid in full when borrowers receive their next paycheck. Additional reports revealed that the California trend reflects trends in other states.
Thomas Leonard, Executive Director of the California Association of Financial Services Providers, said 2020 has been a tough year for the industry as the pandemic has changed the way consumers manage their finances. His association represents providers of small consumer loans, payday loans, check cashing and other consumer financial services.
“Demand for small dollar loans fell precipitously in 2020 as many consumers stayed home, paid off debt, managed fewer expenses and received direct government payments,” Leonard said in a statement.
On the other hand, Cesar said the decline in the use of payday loans isn’t necessarily indicative of Californians’ financial improvement.
“It’s just too simplistic of a picture,” she said. “Cash relief efforts may have helped consumers make ends meet, but people are not off the hook.”
Marisabel Torres, California policy director for the responsible credit center, said that despite the impact of pandemic relief on Californians, some of these programs already have an end date. California’s eviction moratorium, for example, is due to end on September 30. The deployment of housing assistance has been slow. Tenants with unpaid rent are at risk of eviction for those who cannot afford to pay rent.
Once these programs are cut, Torres said, people will continue to need financial help.
“There’s still this large population of people who will continue to gravitate toward these products,” Torres said.
With the exception of last year, the report showed that the use of payday loans has remained stable over the past 10 years. But the use of payday loans doubled in the years following the Great Recession.
The state report doesn’t provide any context on how consumers used payday loan money in 2020, but a to study by the Pew Charitable Trust in 2012 revealed that 69% of clients use the funds for recurring expenses, including rent, groceries and bills.
Nearly half of all payday loan customers in 2020 had an average annual income of less than $30,000 per year, and 30% of customers earned $20,000 or less per year. Annual reports also consistently show higher usage among customers earning more than $90,000 a year, though the Financial Monitoring Service was unable to explain why.
“Basic necessities, like groceries, rent… To live, you have to pay for those things,” Torres said. “Anything that alleviates this economic pressure is helpful to people.”
Lawmakers across California have begun establishing pilot programs that would alleviate some of that economic pressure. Stockton was the first city to experiment with guaranteed income for its residents. Compton, Long Beach and Oakland followed suit thanks to the nationwide effort of Guaranteed Income mayors. California approved its first guaranteed income program earlier this month.
Little regulation, high fees
Payday loans are considered to be among the most expensive and financially dangerous loans that consumers can use. Experts say the decline in usage last year is good for Californians, but the industry still lacks the regulations needed to reduce lending risk for low-income consumers.
California lawmakers have a long history of attempts to regulate predatory lending in the state, but have failed to enact meaningful consumer protections against payday loans. The most notable legislation was passed in 2002, when California began requiring licenses from lenders. It also capped payday loans at $300.
Unlike other forms of borrowing, a payday loan is a short-term loan where the borrower promises to repay the money with his next paycheck. While lenders charge fees instead of interest rates, state regulators require disclosure in terms of interest rates to show how expensive this form of borrowing is for consumers. When annualized, these loans averaged 361% in 2020.
In addition to exorbitant interest rates, one of the industry’s biggest sources of revenue is fees, especially from people who are serially dependent on payday loans.
A total of $164.7 million in transaction fees — 66% of industry fee revenue — came from customers who took out seven or more loans in 2020. About 55% of customers opened a new loan on the day even from the end of their previous loan.
After multiple failed efforts in years past to regulate the industry, California lawmakers are not pursuing major reforms this session to tackle the industry. Torres called for continued legislative efforts that would cap interest rates to alleviate what she calls the debt trap.
“It’s crazy to think that a decision maker would see this and say, ‘It’s okay. It’s normal for my constituents to live in these circumstances,’ Torres said. “While it’s actually within the power of California policymakers to change that.”
Alternatives to payday loans
There is evidence that declining payday activity correlates with COVID-19 relief efforts. While there are a number of factors in the decrease, they likely include the distribution of stimulus checks, loan forbearances and the growth of alternative financing options. More commonly known as “early wage access,” the new industry claims this is a safer alternative.
Companies lend part of a customer’s salary through phone apps and do not charge interest fees. The product is not yet regulated, but the state financial monitoring agency has announced that it start surveying five companies that currently provide the service.
The problem with this model, according to Torres, is that there is no direct fee structure. To make a profit, apps require customers to tip for service.
“Unfortunately, that tip often masks the ultimate cost of the loan,” Torres said, adding that some businesses go so far as to use psychological tactics to encourage customers to leave a big tip.
“Customers expressed their relief knowing that our industry was always there for them in the most difficult of circumstances and we were proud to be there during this time of need,” Leonard said.
Despite last year’s downturn, 1.1 million customers borrowed a total of $1.7 billion in payday loans last year, with 75% returning for at least another loan in the same year.
Torres said the Center for Responsible Lending continues to work with lawmakers to draft bills that would cap interest rates to make payday loans more affordable. Requiring lenders to assess the customer’s ability to repay the loan would also prevent customers from falling into a debt trap, she said.
“They act like they’re providing that lifeline to somebody,” Torres said. “It’s not a lifesaver. They tie (customers) down with an anchor.
For the record: a previous version had the wrong year that California capped payday loans. That was in 2002. The story has also been updated to clarify how payday loans work and how borrowing costs are disclosed to consumers.
This article is part of the California Divisiona collaboration between newsrooms examining income inequality and economic survival in California.