Many families take for granted that they can fix their water heater when it breaks, or take their child to a dentist if she has a toothache.
But in reality, more than half of American households -- not just poor people -- have less than a month's worth of savings, according to Pew studies. And about 70 million Americans are unbanked, meaning that they don't have or don’t qualify for a traditional banking institution. So what happens when a crisis hits and there isn't enough savings to cover it?
Between 30 to 50 percent of Americans depend on payday lenders, which can charge exorbitant interest rates of 300 percent or more. Earlier this spring, the Consumer Finance Protection Bureau announced its plan to crack down on payday lenders by limiting who qualifies for such loans and how many they can get.
“We are taking an important step toward ending the debt traps that plague millions of consumers across the country,” said CFPB Director Richard Cordray. “The proposals we are considering would require lenders to take steps to make sure consumers can pay back their loans.”
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Last week, 32 Senate Democrats called on the CFPB to come down on payday lenders with the “strongest rules possible,” calling out payday lending practices as unfair, deceptive, and abusive. They asked the CFPB to focus on “ability-to-pay” standards that would qualify only borrowers with certain income levels or credit histories.
Payday lenders can be exploitative, but for millions of Americans, there aren’t many alternatives, and solutions lie not just in regulating “predatory” lenders, but in providing better banking options, some experts say. "When people go to payday lenders, they have tried other credit sources, they are tapped out, and they need $500 to fix their car or surgery for their kid," says Mehrsa Baradaran, a law professor at the University of Georgia and author of "How the Other Half Banks."
"It's a common misconception that people who use payday lenders are 'financially stupid,' but the truth is that they have no other credit options."
Two forms of banking
There are "two forms of personal banking" in America, according to Baradaran. For those who can afford it, there are checking accounts, ATMs, and traditional lenders. Everyone else — including 30 percent of Americans or more — is left with "fringe loans," which include payday lenders and title loans.
Reliance on payday lenders shot up between 2008 and 2013 when traditional banks shut down 20,000 branches, over 90 percent of which were in low-income neighborhoods where the average household income is below the national medium.
Payday lenders flooded in to fill the gap. With over 20,000 outlets, there are more payday lenders in American that Starbucks and McDonald's combined, and it's a powerful $40 billion industry.
Even low-income individuals who do have local access to a bank are not necessarily being financially irresponsible by using a payday lender, according to Jeffery Joseph, a professor at the George Washington Business School.
He points out that other financial products can also be expensive for low-income people because they require minimum balances, service charges, and punitive fees for bounced checks or overdrafts, as do credit cards with late fees and high interest rates.
High debt, low on options
Still, payday loans are structured in ways that can quickly spiral out of control. The Pew Charitable Trust has studied payday lenders for years and found that the average $375 two-week loan ballooned to an actual cost of $500 over the average payback time of five months.
The average unbanked family with an annual income of $25,000 spends about $2,400 a year on financial transactions, according to an Inspector General report. That's more than they spend on food.
And yet, the demand for payday loans is booming and surveys find that borrowers have surprisingly high satisfaction rates. A George Washington University study found that 89 percent of borrowers were "very satisfied" or "somewhat satisfied," and 86 percent believed that payday lenders provide a "useful service."
Responses to the Pew study suggest that users may feel relief utilizing unfavorable loans because they are desperate for options.
"Borrowers perceive the loans to be a reasonable short-term choice, but express surprise and frustration at how long it takes to pay them back," Pew reported last year. "Desperation also influences the choice of 37 percent of borrowers who say they have been in such a difficult financial situation that they would take a payday loan on any terms offered."
What's the alternative
New CFPB regulations would require payday lenders to have evidence that borrowers can repay their loans before they make them by verifying income, debts, and credit history. That concerns people like Joseph because that will limit loans to some of the people who need them the most and may even drive them to loan sharks.
The City of San Francisco started its own banking partnerships to address its unbanked population after a 2005 study found that 50,000 San Franciscans were unbanked, and that included half of the adult African-Americans and Latinos.
The city’s Treasury Office teamed with The Federal Reserve Bank of San Francisco, nonprofits and 14 local banks and credit unions to provide low-balance, low-fee services. Previously unbanked San Franciscans have opened accounts since 2006.
San Francisco also offers its own “payday loan” services with much more reasonable terms. Borrowers can get up to $500 and repay over six to twelve months at 18 percent APR, even for borrowers with no credit scores.
Baradaran favors a solution that sounds radical, but is actually common in most other developed countries -- banking via the Post Office. The United States Postal Service could offer savings accounts, money transfers, ATMs, debit cards, and even small loans, without the onerous fee structures imposed by private lenders.
The Post Office is in a unique situation to serve the unbanked, she argues, because it can offer credit at much lower rates than fringe lenders by taking advantage of economies of scale, and thanks to the friendly neighborhood post office, it already has branches in most low-income neighborhoods.
People at all income levels are also reasonably familiar with the Post Office, which might make it more approachable than formal banks.
The U.S. had a full-scale postal banking system from 1910 to 1966. "It's not radical, it's a small solution to a massive problem," she says. "It's not a handout, it's not welfare, it's not a subsidy," she says.
"If we don't provide an alternative, it pushes people into the black market."