Predatory Lending: Problems with Payday Loans
High-interest usurious lending has existed for all of human civilization, and in modern times has taken the form of payday loans. Payday lending is a subset of predatory lending that involves uncollateralized short-term, small-dollar loans. Borrowers take out a loan by writing a check to a lender for the amount borrowed plus fees. The borrower must repay the entire amount on the next payday, usually between two weeks and a month after taking out the loan. If a borrower is unable to pay the entire principal, the borrower can generally pay to have the loan renewed or take out a new loan. Payday loans present a number of issues. Unlike borrowers of larger collateralized loans, payday borrowers are not required to demonstrate virtually any ability to pay back a loan. In many states, the only requirement is that a borrower has an income and a bank account.
These loans also have excessively high interest rates, which can be up to 780% calculated per year. This can lead to a devastating debt spiral in which borrowers sink deeper into debt as they attempt to pay back their loans.
After the 2008 financial crisis, the media has increasingly portrayed borrowers in a more situational light. This change in framing has opened the doors to possible policy and tort solutions to predatory small-dollar loans.
From a policy perspective, states can place outright bans on small-dollar loans, but that might push borrowers to other problematic alternatives. There are other policy options, however, that would allow payday loans to function in a less predatory manner. The balloon payment structure could be replaced with an amortizing schedule resembling more traditional loans. Interest rate caps could ensure that lenders do not demand triple-digit interest rates. The system could also be made more
transparent so that borrowers would truly know the risks of borrowing.
Torts may present a solution either within existing tort doctrine, or by creating a new tort. Potential plaintiffs may be able to sue payday lenders based on misrepresentation or negligence. If the loans were viewed as products, borrowers could sue under the theory of products liability as well. Creating a new tort could be the strongest way to address predatory lending. The tort of abnormally dangerous lending would serve as an ex-post way of preventing borrowers from entering a debt spiral. Both borrowers and lenders would present their stories to a neutral fact-finder who would determine if a loan had been abnormally usurious. If the loan was found to be abnormally usurious, the borrower would have to pay back the principal but none of the fees or interest.