Mayday for Payday Loans

On April 2, 2007 The Wall Street Journal published the following editorial.

Mayday for Payday Loans

In the wake of the subprime loan meltdown, Congress and many statelegislatures are now promising a crackdown on the "payday" loan industry.This looks like another illustration of how to hurt working Americans in thename of helping them.

Payday lenders offer short term loans, typically of between $100 to $500, toworkers who need cash in advance of their next paycheck. Consumer groups andbanking industry critics complain that the fees charged on payday loans are"predatory" and ensnare the poor in a "debt trap." The Center forResponsible Lending, a liberal activist group, claims the industry costsAmericans $4.2 billion a year by charging exorbitant fees.

Several dozen U.S. Congressmen recently signed a letter excoriating paydaylenders as "unscrupulous." Last year, Missouri Republican Jim Talent waslooking for a populist issue to save his Senate seat, so he led the fight inCongress to enact legislation chasing payday lenders from military bases.Mr. Talent still lost, but he helped set a precedent that Democrats arepursuing with more onerous measures now.

But if payday lending is such a consumer rip off, no one has explained whythese stores have become so popular. There are some 25,000 payday storesacross America, and in many small towns the payday loan store is now ascommonplace as the local post office. It has become something like a $6billion industry serving 15 million people every month.

Consumers seem to like the convenience of instant cash in advance of theirpaycheck and prefer this to pawnshops or borrowing money from familymembers. Payday lenders have grown in size, customer base and profitabilityby discovering an unserved niche in the loan market for convenient, shortterm micro-loans. More to the "populist" point, payday loans offer avaluable service to moderate income workers. Most borrowers have incomesbetween $25,000 and $50,000, and payday loans are cheaper than mostalternatives for those facing short-term financial distress.

Critics complain that the annual percentage rate (APR) on a two-week loan of$100 with a $15 fee amounts to a predatory 390%. But the equivalent APR costto the borrower of writing a bounced check can exceed 1,300%, while a creditcard late fee charge can reach 700%. Some borrowers will also go to loansharks as an alternative, and we know how high their "fees" can be.

Georgia outlawed payday loans in 2004, and thousands of workers have sincetaken to traveling over the border to find payday stores in Tennessee,Florida and South Carolina. So the effect of the ban has been to increaseconsumer credit costs and inconvenience for Georgia consumers.

The most common proposals in Congress would cap payday loan interest ratesat 36% APR. This would cut the fee to $1.38 for a $100 loan, less than thecharge for a typical $100 ATM fee, and far below the check transaction cost.This could shut down much of the industry. But to what end? This debate ismuch like the controversy over bank ATM fees a few years ago. Consumer advocates demanded laws capping fees, and where those took effect the resultwas not so much lower charges but fewer ATMs and thus less convenience.

A 2007 New York Federal Reserve Bank study rejects the notion of payday aspredatory and concludes that high prices "may reflect too few paydaylenders, rather than too many." It adds that more regulation could reducemarket entry and "the lack of competition could drive rates higher." Banningpayday loans might please competing banks, credit unions and so-calledconsumer advocates, but it's hard to see how actual consumers would benefit.

This interesting editorial makes the point that payday loans are not necessarily the most expensive alternative out there. This is clearly the reason 15 million people use the service each month. Keep in mind, they didn't say payday loans were cheap. Clearly payday loans are an expensive proposition. Always remember rolling existing payday loans can be a disaster financially.

Please always borrow responsibly. If you take payday loans online, please only borrow what you will be able to pay back when you get paid from your job and still have money to get through the month.