Modern payday lending, with its two-week timelines, high costs, and lump-sum payments, emerged in the early 1990s. According to The Pew Charitable Trusts' most recent market scan, 18 states and Washington, D.C., do not have payday loan stores because their laws limit interest rates and other terms, while four of the remaining 32 states have enacted comprehensive payday and small-dollar loan reforms.
In this interview, Alex Horowitz, who has led Pew’s small-dollar loans research for more than 10 years, discusses how policymakers and advocates can successfully reform their state lending laws.
The interview has been edited for length and clarity.
Most payday loan laws were written on the mistaken assumption that a single-payment loan would help struggling consumers without getting them into long-term debt. But this hope has not been borne out, since typical payday loan customers are in debt for about half the year and pay about eight times the loan’s originally advertised price. It’s a failed market, and financially struggling households keep getting trapped in it. That’s why it’s ripe for reform.
They haven’t. The Consumer Financial Protection Bureau (CFPB) issued modest payday loan rules in 2017—and then rescinded them in 2020. And more importantly, no federal regulator has authority over key pricing and lending terms that are essential to proper reform—but state lawmakers do.
One option is to eliminate high-cost credit at the state level. For example, since 2016, South Dakota, Nebraska, New Mexico, and Illinois have all capped rates for state-licensed credit at around a 36% annual percentage rate. These caps can protect consumers from payday and other high-cost loans as small loans—typically about $1,000, or less—become increasingly available from banks and credit unions.
The other choice is for a state to comprehensively reform its payday and small-dollar loan laws, such as lawmakers in Colorado, Hawaii, Ohio, and Virginia have done. This is proven to keep credit flowing to consumers—at much lower cost than payday loans have offered up to now, and with much better, more transparent outcomes.
Pew’s research suggests that in states where payday loan stores don’t exist, would-be borrowers choose other options such as asking friends, negotiating with debtors, or cutting expenses. The good news is that since 2018, banks have entered this market in a big way, and credit unions are expanding their small-loan offerings, too. All payday loan borrowers are already bank or credit union customers with checking accounts. And now millions of these consumers can get cheaper and safer small loans from their banks or credit unions instead of from a payday loan store.
States with high-cost loans should modernize their laws governing this credit. The key is to give consumers more time to repay their loans—with affordable payments and fair prices.
Here’s what’s happened in Colorado, Hawaii, Ohio, and Virginia after those states reformed their consumer credit codes: Consumers with damaged credit histories still have access to small loans but on much better terms than before. Payday loan stores continue to provide credit, as do state-licensed installment lenders—companies that provide small loans based on borrowers’ ability to repay and do not rely on access to customers' checking accounts as collateral—and financial technology firms, which have expanded their offerings. The interest rates on loans available in states that have passed reforms are still higher than on credit cards, but they are three to four times lower than before, saving typical borrowers hundreds of dollars each. Some payday loan stores have closed, and each remaining store serves more customers—which is where a lot of the consumer savings comes from.
The reforms in Colorado and Hawaii were fairly narrowly focused, but the bills enacted in Ohio and Virginia were broader.
Virginia’s 2020 bill is a great example of successful reform. It enacted meaningful consumer protections, and even though some lenders objected loudly, others supported the bill because they recognized it was fair to them and would allow them to offer installment loans, which they have done. The bill created uniform standards for payday, auto title, and mainstream installment loans (“consumer finance” loans); it also capped allowable rates on open-end credit and prevented loan brokers (“credit services businesses”) from adding fees to small-dollar loans. Pew published both a high-level analysis and a detailed, section-by-section summary of the Virginia law.
And in each of the four states, the successful law change eliminated the single-payment feature of payday loans and gave consumers more time to repay.
It’s absolutely essential. That’s the root of the problem.
The single lump-sum payments on payday loans take up a third of the typical borrower’s paycheck. And the lender has access to the consumer’s checking account, so the lender can collect even if the borrower can’t afford to repay without quickly taking another loan. That’s why the average payday loan customer who signs up for a two-week loan ends up in debt for five months and pays more in fees than they originally received in credit.
A successful payday loan reform law must require all state-licensed payday and small-loan lenders to offer loans that are repaid over a period of several months, in affordable installments and at fair prices, and to set other reasonable safeguards.
Borrowers need enough time to repay and payments that take up a small share of their paycheck. And each payment should pay down principal, with the costs spread evenly over the loan to minimize the lender’s incentive to encourage repeated borrowing. Also, critically, the interest rate, monthly fees, and total cost of the loan must be limited and disclosed fully. For example, in Virginia, a lender can charge a maximum interest rate of 36% and a maximum maintenance fee of 8% of the original loan amount, not to exceed $25 a month—and the total loan costs are capped at half the principal or 60% for larger loans.
Each law includes anti-evasion provisions. For example, by making unlicensed loans void and unenforceable, unauthorized internet loans become much harder to collect, which discourages unscrupulous lending.
Well, several state efforts to regulate this market have failed. Along with requiring all loans to be repayable in affordable installments at fair prices, the most important thing is to make the legislation tight and avoid loopholes. Some states have failed because they capped one part of the code—the payday loan statute, for example—but not another part, like the open-end credit code, which allows lenders to charge unlimited fees or interest for lines of credit.
In states where there’s been no reform, storefront payday lenders are still primarily single-payment loan providers—but they also sometimes operate as installment lenders, auto title lenders, open-end credit providers, and even brokers or credit service organizations. That’s why the bills in Colorado, Hawaii, Ohio, and Virginia were successful; they covered every kind of high-cost small-dollar loan without leaving loopholes.
Pew offers a series of reports about payday lending, as well as a payday loan explainer, a short video about how state reforms have saved borrowers more than $1 billion, and a longer video about Ohio’s 2018 success.
Writing a bill requires familiarity with a state’s consumer credit code and someone who is comfortable with the key tenets of reform. I’ve found it useful to talk with legislators and advocates in states that have reformed their laws like the Virginia Poverty Law Center, which led the reform effort in Virginia.