Consumer advocates and those trying to protect the less fortunate are gearing up for a fight that probably won’t take place during this year’s short legislative session, which officially started Jan. 19. Officially started, but in reality little work gets done until after the long weekend.
The fight that probably won’t happen is over interest rates charged on short term loans, often called payday or title loans. The folks battling to lower the rates have made great progress over the years. They succeed in 2017 to getting the rates charged on small, short-term loans to 175 percent. They’d like to see that number be 36 percent.
The arguments on both sides are strong and based in fact and common sense. We understand both sides disagree with that last statement. But from the outside, looking in, a reasonable person can understand why legislators struggle with this issue.
Advocates say it’s too much and takes advantage of the poor. There are 1,300 stores in New Mexico and most are close to reservations.
Lobbyists for the industry insist they fill a need and the high interest rate is necessary for the business model. In short when one person doesn’t repay a loan, the high interest rate model allows other payers to “cover” the company’s loss. Dead beats are built into the model.
A 2013 Federal Deposit Insurance Corporation study found nearly 30 percent of New Mexico households used one or more of these loan services. Most were not homeowners, 25 to 34 years old, Hispanic, lacked a high school degree and had family income of less than $15,000.
A bank would take a simple glance at such a person’s household balance sheet and send them packing. So where are they to go? In that regard these lenders fill a badly needed niche.
The problem starts when someone is allowed to borrow more than they can repay, with a shorter repayment schedule and a balloon payment. This harkens back to the real estate collapse in 2008. Same circumstances, bigger loans. The same study found longer term loans were more likely to be paid back than short term (under 120 days). That’s because the longer the term, the lower the payments.
But then we get into the math of compound interest, which is forever working quietly against a borrower. When the balloon payment is missed or smaller payments are pushed back, the interest comes crashing down on borrowers. A loan they could maybe, barely afford becomes completely unaffordable and gets more so monthly.
Northern New Mexico College’s former president Rick Bailey set up a loan program in 2019 for Northern employees with True Connect. Through that lender employees may borrow money within their means to repay. Payments are made through the College’s payroll system so there is a guarantee of repayment. This allows a more affordable interest rate.
Northern Human Resources Director Kenneth Lucero said the loans are at a 30 percent rate and he’s seen $1,700 to $2,300 payouts. The loans run from one at 88 days to some running one year.
He said he didn’t know how successful the program is but, “I would think it is helping with the higher rate market.”
This is a good answer to the problem but that sort of system won’t be found at Burger King, Walmart or Chili’s. The employee turnover is huge, benefits few, pay low and repayment could not be guaranteed. Those types of employees will continue to be pushed into the “predatory loan” market.
A 2018 FDIC study found when the interest rates for short term lenders was lowered to a certain point, lenders left the state. However, the number of average loans remained fairly consistent. The remaining lenders picked up the slack and made the business model work. It’s not reasonable to assume that will work as states continue to approach the magical 36 percent rate. Eventually, the business model won’t work and they’ll leave the state.
Where does that leave the people who need these loans to get through emergencies?
The long term answer is force financial management classes in all high schools. Someone with a $1,000 iPhone doesn’t need a loan they need education. People need to learn how to handle their money before they have money. We strongly suggest math teachers use interest rates for problem-solving in classes often and regularly throughout high school.
The short term answer is creating a business model that works for lenders and borrowers. Changes should include no balloon payment to crush a borrower, fair interest rates with payments that are affordable, make loan schedules long enough to allow those lower payments.
Another change that must be made is to stop borrowers from taking multiple loans from different companies. We’ve heard many horror stories of people borrowing from one lender to pay another, only to fall behind at both. Then they move on to a third lender.
This does not describe a borrower in an emergency. It’s someone who cannot manage their money. They need education, not more “expensive” money to spend frivolously.
We need a lender business model that works for borrower and lender. We’re not sure continually lowering the rate, without changing the business model will work for either one.