Payday lending is evolving, and not for the better

The payday lending industry is evolving, but its newest products may simply provide consumers with a different route into a money hole.

Payday lenders are increasingly turning to installment loans, with all of America's biggest payday lending companies now selling the products, according to new research from Pew Charitable Trusts. Instead of requiring repayment of a loan within days or weeks, these products are repayable over several months.

On the face of it, these loans may seem like a better deal for borrowers because they provide more time to repay the lender, and consumers tend to prefer an installment payment structure, Pew found. Yet the foundation is warning that the installment loans carry many of the same hallmarks of the traditional payday loans, such as sky-high interest rates. And lenders are shifting to installment loans partly because the products sidestep some state regulations and the Consumer Financial Protection Bureau's (CFPB) proposed payday lending rules.

"Ohio is the poster child for one of the worst instances of this," said Nick Bourke, director of the small-dollar loans project at the Pew Charitable Trusts. "They tried to regulate, but what they did ended up encouraging payday lenders to make installment loans.... They didn't put anything in the law that governs the way these new payday loans operate. Lenders are making loans effectively outside of regulation."

Payday and auto title lenders are selling installment loans in 26 of the 39 states where they now operate. In some states, they are operating under credit services organization statutes, which allow companies to broker loans, such as in Ohio and Texas. Payday lenders charge fees to borrowers for brokering loans that are sold to other lenders, sidestepping some states' laws capping interest rates.

"This brokering is an evasion of low interest rate limits because the fees charged are in addition to the interest paid to the third-party lender and significantly increase borrowers' costs," the Pew report noted.

The CFPB said it has extensively researched high-cost installment plans, and found that more than one-third of loan sequences end in default, often after the borrower has refinanced or reborrowed.

"The CFPB's proposed rule would cover lenders making high-cost installment loans where the lender has the ability to extract a payment from the consumer's bank account or wages, or when the lender takes a security interest in the consumer's vehicle," CFPB spokesman Sam Gilford said in an email. "Lenders would be required to assess the borrower's ability to repay the loan, and the proposal sets out a specific, clear methodology for lenders to use."

Ohio's regulations cap payday loans at a 28 percent interest rate, but by brokering loans lenders are getting away with charging far more, the research found. In one example, a $500 installment loan in Ohio with a 26-week repayment schedule has an APR of 360 percent, the researchers found.

In another Ohio case, a consumer complained to the CFPB about taking out a payday loan for 47 months that was immediately turned over to another lender. After several months, the borrower couldn't continue to make the payments. The consumer, who said the lender called their family and friends, as well as threatened a lawsuit, eventually provided a Social Security debt card.

That complaint illustrates one problem with installment loans: They appear to provide more flexibility for borrowers, but they share the same risk as shorter-term payday loans that borrowers will become trapped in a cycle of unaffordable debt repayment.

In other words, installment plans don't equate to affordability. Payday installment loans typically eat up between 7 percent to 12 percent of the average borrower's gross monthly income, higher than the affordability threshold of 5 percent, the research noted.

Because of the threat of regulation from the CFPB and mounting scrutiny from state lawmakers, payday lenders appear to be increasingly shifting their business models to installment lenders. Payday lenders in Texas have increased their revenue from installment loans from 27 percent of revenue in 2012 to 67 percent last year, Pew said.

Pew wants state and federal lawmakers to pass legislation that would limit excessive duration loans, unaffordable payments, front-loaded charges and non-competitive pricing.