Hard money lending is highly controversial. While it certainly has its place in the world of real estate investing, one form of it has received a bad reputation, which is that of payday loans. These loans attract everyday individuals stuck in a financial conundrum, but then trap them in an increasingly deep hole of debt. Now, it seems that a new system will allow banks to offer short term loans, and to do so in a way that is much safer for the average American. But is that even possible?
High-Risk Hard Money Lending
What attracts people to payday loans is that they are for low amounts and very short term. While they have interest rates of 300% or above, the fact that they are short term means that people effectively only pay around $60 in interest. People know they are dangerous, yet continue to apply for them.
People use payday loans to avoid borrowing from family and friends, and to avoid cutting back further on expenses. But they often end up doing those things anyway to pay back the loan.
The problem with payday loans is that most people simply do not have the ability to repay them, which means they roll them over instead, paying only the fees. A recent report by the Pew Charitable Trusts showed that, on a $375 loan, the average paid in fees is $520. Suggestions have been made to resolve this, including:
- Allowing payday loans to be turned into installment loans instead
- Limiting how much the borrowers have to repay to 5% of their monthly earnings
According to the Pew Charitable Trusts, doing so could save consumers around $10 billion per year.
A Better Solution
To help people avoid debt traps, the Consumer Financial Protection Bureau has put new underwriting requirements in place.
The rule generally requires that, before making such a loan, a lender must reasonably determine that the consumer has the ability to repay the loan. The Bureau has exempted certain short-term loans from the ability-to-repay determination prescribed in the rule if they are made with certain consumer protections.
What is perhaps more interesting is that, on the very same day, the Office of Comptroller of the Currency rescinded their rulings that made it all but impossible for banks to offer small-dollar loans.
The final rule regarding short-term, small-dollar loans submitted to the Federal Register by the Consumer Financial Protection Bureau necessitates revisiting the OCC guidance.
What this effectively means is that people can now once again turn to their banks in order to apply for small loans, and they are likely to get them. However, this doesn’t resolve the issue at hand, which is that people simply do not have enough savings to meet financial emergencies. Indeed, research has shown that 44% of people in this country would not be able to raise $400 in case of an emergency.
Not just that, but there will always be a place for hard money lenders, because of the role they play in real estate purchases. Because these lenders are private lenders, it is at their discretion to determine who they loan to, and under what circumstances. And considering that, despite the October regulations, the demand for residential hard money lenders continues to rise, and it seems that there will always be a place for them. Perhaps, it is time for a reclassification that no longer sees a payday lender as a hard money lender. In so doing, the industry could be more fairly regulated, while at the same time protecting the average American from the predatory practices of the payday lender.