Payday Loans: Colorado Reforms and Their Impact on the Industry

January 8, 2014

We have all seen the signs advertising payday loans – on billboards, storefronts, and bus stops. “Easy Money.” “$1,000 approved in 2 minutes.” But these loans often carry very high interest rates and lenders in this area have been accused of taking advantage of people who don’t understand the rates and who then find themselves trapped in a cycle of debt.

The loans carry such a high cost and have such a short repayment period that borrowers find they cannot pay off the loans and must take out another loan to pay off the last loan. The way the loans work is pretty simple – get $1,000 (or any other denomination) in cash now (or in 2 minutes if you believe the advertisements), and they pay it back when you receive your next paycheck, plus the fees/interest that have accrued. If you can’t pay it all when you get your next paycheck, then you can pay the fees and continue the cycle until your next paycheck.

The Community Financial Services Association of America argues that payday loans (or short-term loans as they call them) are “financial empowerment for consumers.” The Association, on its Myth vs. Reality page, states:

“There is no statistical evidence to support the ‘cycle of debt’ argument often used in passing legislation against payday lending...The vast majority of Americans, undeniably, use payday advances responsibly and, as intended, for short-term use.”

Some states have banned payday lending altogether. Rather than banning the loans, in 2010 the Colorado Legislature implemented new laws to reform the industry in Colorado. Under the new laws, there is a maximum loan amount of $500, with a minimum loan term of six months. Rather than having a single, lump-sum payment due in a very short window of time, the new loans are structured as a series of installment payments over the six month period. Further, the law limits the fees that can be charged and allows interest of up to 45 percent. Lenders must refund a portion of the fees if the loans are prepaid in full prior to maturity.

In 2012, the Colorado Attorney General reported that the reforms were working and that the number of loans and the number of licensed lenders had decreased.

A November 2013 study commended the reforms made in Colorado, stating that overall, the reforms had a significant impact on the loan business in Colorado and that the reforms could be used by other states considering reforming payday loans rather than banning them. Key findings from the study:

  • In the 35 states that allow lump-sum payday loans, repayments require approximately one-third of the average borrower’s paycheck. In Colorado, payments only take an average of 4 percent of the borrower’s paycheck.
  • Payday loan safeguards can be applied in a way that works for lenders. Payday lenders continue to operate in the wake of the Colorado reforms, but borrowers are spending 42 percent less money than they did under the old law, and payments are far more affordable.
  • Payday borrowers strongly support requiring the loans to have affordable installment payments.

The Colorado reforms strike a balance between protecting consumers from harmful practices while still allowing them access to short-term loans. As Colorado concludes the third full calendar year that the reforms have been in place, new data will be available to assess how well the reforms continue to work in the state.

What do you think about payday loans? Should Colorado follow the move of 15 other states and outlaw the loans all together, or do the reforms provide sufficient protection to consumers? Leave your thoughts in a comment!