Where Things Stand In The Short Term Loan Industry

More consumers than ever before are turning towards short term loan providers for financing needs. Meanwhile, online lenders are looking to capitalize on the growing demand. Many online lenders, provide a marketplace that connects borrowers with investors.

Prospective borrowers are encouraged to do their proper research prior to proceeding with a short-term loan. There are many reputable resources on the web which offer a more in depth overview of the loan process and what to expect.

As is typically the case with any industry in its infancy, the government likes to step in and slap on rules and regulations - for better or for worse. A CNN Money report looked at what new rules or regulations the Consumer Financial Protection Bureau will implement.

First, the bureau could force payday lenders to better evaluate the feasibility of a client to be able to repay the loan in the first installment. The CFPB is proposing that lenders oversee a "full-payment test" or a mini-stress test to see if a borrower can afford to make payments to repay the loan while also being able to meet their basic living expenses and other financial obligations.

Debt Trap Cycle

The CFPB coined a term called "debt trap" which essentially results in a borrower re-issuing or refinancing an already existing loan to repay back the original loan. In fact, the CFPB estimates that more than 80 percent of payday loans are re-borrowed within one month.

New rules could ban lenders from issuing a similar loan to a borrower within 30 days of paying off a prior short-term loan and also restrict when a loan be refinanced.

Fee Regulations

CNN Money cited data from The Pew Charitable Trusts which showed that the average payday loan borrow can end up spending as much as $520 in excessive fees to repeatedly borrow $375.
Lenders typically have access to a borrowers' bank account and can automatically collect their payments. If the borrower does not have sufficient cash in their bank account to cover the payment then they would be charged massive NSF fees from both the borrower's bank and the lender.

Will This Work?

Valuewalk, a popular financial news and analysis website, commented on the CFPB's proposal, suggesting that most of the policy makers are "thinking with their hearts" and are oblivious to the facts.

For starters, why should short-term lenders be held to a higher standard than any other company in terms of their profit margin. Why aren't government regulators targeting consumer goods and electronic companies, such as Apple Inc. AAPL who sell an iPhone for $699 that costs just $200 to make.

"So why should short-term lenders be held accountable any differently than Apple?," Valuewalk questioned. "Shouldn't short-term lenders be able to charge at interest rates that make up for the huge risk they incur in lending money out to low-income borrowers?"

Valuewalk also questioned some of the logic proposed by the CFPB. As an example, one of the requirements would force lenders to conduct a "full-payment test" but doing so is very expensive and time consuming.

The result of forcing lenders to conduct "full-payment test" will either result in loan companies shutting down because of the added costs which hurt their bottom line or only loan out large sums of money to better manage their business.