Payday loans are rising, but a Minnesota proposal might soon put an APR cap on them

Sherry Shannon thought a payday loan would cover the unexpected expense of fixing a flat tire.

Shannon, who feared becoming homeless again, was broke at the time and felt she had no other alternative than to borrow $140 for the repair at a triple-digit interest rate.

"I thought, 'Two days later, I'll get my check and pay them back,'" she recalls. "But it wasn't as easy as I thought it was. It was the interest rate that got me."

That started a cycle of borrowing from the payday lender resulting in another $500 in borrowing costs. Who knows how much higher that amount would have climbed if she hadn't received a 12-month, interest-free loan from nonprofit Exodus Lending to cover all the payday loans.

A decade later, 67-year-old Shannon is now an advocate for capping payday loan interest and fees, including a current proposal in the Minnesota Legislature. The short-term, small-dollar loans are for borrowers needing quick cash for sudden, pressing expenses they can't immediately afford.

"They target certain people," said Shannon, who is Black and feels these loans prey on communities of color. "That's why they're in certain areas where people live who are low-income, fixed-income."

The proposal seeks to cap the annual percentage rates (APR) on payday loans at 36%, which financial experts consider the maximum APR a loan can have to be affordable. The proposal is currently in the conference report for the commerce budget bill and should come to a vote in the next two weeks.

Payday lenders say the change could threaten their business model and force their borrowers to potentially take on more risk by going to unregulated, unlicensed online lenders.

"The proposed legislation does nothing to help those we serve," Payday America chief executive Brad Rixmann said in a statement.

So far, 18 states have adopted the 36% rate cap. The military also enacted the cap for active-duty members.

U.S. Bank's Simple Loan is an example that already meets the rate cap. According to the bank, for every $100 borrowed, there's a $6 fee. Borrowing $400 results in a $24 fee for a total of $424 paid back in three monthly payments. The total cost to borrow (or APR) will be 35.65%.

At an APR of 220% — last year's average in Minnesota — borrowing $400 results in a total repayment of $484.05, more than three times the APR costs in the U.S. Bank example. For people living on the financial edge, the difference is major.

Anne Leland Clark, executive director of Exodus Lending, favors the cap to protect those struggling financially from a spiraling cycle of high-interest debt.

"The majority aren't using this for an emergency. People are using it for a shortfall," she said. "If I have a shortfall this month, what's the likelihood that I'll have the money next month to make up the shortfall and pay this back?"

The challenge comes for those who can't repay the loan by their next payday, the usual due date.

"The business model of payday lenders is predatory and traps people," said Yasmin Farahi, a deputy director of the Center for Responsible Lending in Durham, N.C.

To avoid triple-digit interest today, Clark recommends that those in a pinch should turn to their bank or credit union for help first, as some, such as U.S. Bank, are adding small, short-term cash loans with more favorable terms than payday lenders.

Minnesota Department of Commerce data, aggregated through self-reported numbers from payday loan lenders, indicated that average annual interest rate for payday loans rose to 220% last year from 197% in 2021, according to Exodus Lending. This was an average annualized percentage and included the fees of many borrowers who roll over their loans several times.

As inflation has shocked many household budgets, the commerce data Exodus Lending obtained also reveals an increase in the total amount of individual payday loans — up $3.2 million — and the total average dollar amount of each loan — up $59 — from 2021 to 2022.

Shannon said she wishes she'd understood the risks of payday loans 10 years ago.

"If I was aware of this," she said, "I would have taken a different avenue."