Procter – a Missouri state extension specialist and professor of personal financial planning at the University of Missouri – can recount how a local payday lender essentially propositioned a member of her financial counseling group who has obvious cognitive disabilities while he was in the drive-through line at Taco Bell, only to be rebuffed by a caseworker sitting beside him.
“One of the lenders that he had borrowed from spotted him. [The lender] stopped his car, turned around, pulled into the parking lot, slammed on the brakes, ran up to the passenger side where he was sitting and said, ‘Hey, buddy, I’ve got $400 just waiting; all you’ve got to do is come down and sign for it today,’” Procter recalls. “His caseworker leaned over – he didn’t know what was going on – and said, ‘You need to back off,” and he did go away. But I think the moral of that story is no matter what, they’re still going to come after you.”
She’ll also tell you about how the shadiness of the industry drove a former payday lending company employee into the University of Missouri’s doctoral program so that he could work to help correct the injustices he once helped facilitate. His name is Graham McCaulley, and his stance on the value and purpose of payday loans is clear.
“In my experience these loans are not designed as a short-term, one-time solution, as the companies like to say they are, but are instead intended to keep people trapped in a cycle of debt and to prey upon the elderly, disabled, poor, and minority populations,” he told CardHub. “We were trained to push people toward bigger loans and encourage them to pay them back as slowly as possible. That way the company could make the most money. It did not matter if customers had loans out at other payday lending stores or were living off small fixed incomes. Credit worthiness was not really important.”
While they’re certainly interesting, those of you who are unfamiliar with payday loans might fail to grasp the significance of these tales. So, let’s take a closer look.
Taking Stock of the Payday Loan Market
A payday loan, in case you don’t know, is essentially a high-interest advance on one’s paycheck. Payday loans are billed as a short-term solution for temporary cash-flow issues, but they’re not necessarily marketed or used for that purpose.
Just consider the following statistics from a recent Pew Charitable Trusts study:
- 12 million people take out payday loans each year, spending $7.4 billion in the process.
- While the average payday loan requires repayment of more than $400 within two weeks, the average borrower can only afford to repay $50.
- The average payday loan is for $375, yet leaves the borrower indebted for five months and on the hook for $520 in interest.
“Seven out of 10 payday loan borrowers use the loans to pay for things like rent and utilities and other recurring expenses,” adds Nick Bourke, the director of Pew’s Safe Small-Dollar Loans Research Project. “Only 1 in 6 use the loans for emergencies like unexpected car repairs or unexpected medical expenses. … Ninety-seven percent of payday loan volume goes to people who are repeat users – they use three or more loans per year.”
In other words, we have a product that’s ostensibly meant to provide a short-term financial bridge, yet whose marketing by lenders and ultimate use by consumers are often directly at odds with that intention. The result is a questionable landscape in which actors on both sides are pointing fingers about who is to blame for high costs and financial distress. Many on the consumer side of things are also calling for increased regulation.
The Current Regulatory Environment
To date, 15 states have banned payday loans while others have passed legislation to significantly limit their impact. But why stop there?
Procter believes payday lenders simply have too much at stake and are too effective at both lobbying and skirting the spirit of laws while at the same time adhering to their letter for additional regulations to move forward.
The payday lending industry has deep pockets, you see, and is able to make key contributions to political campaigns as well as media blitzes in opposition to ballot initiatives in order to ensure their business continues to thrive. They’re also notorious for a practice known as “license jumping,” which essentially involves tweaking their products just enough to keep them both legal and just as predatorily profitable as before.
Payday lenders are also increasingly moving operations online in order to avoid local restrictions. Plenty of physical stores remain nonetheless, and they’re typically clumped together in low-income urban areas, essentially hunting in packs.
“They’ll be very close to one another so they can refer clients back and forth,” Procter said. “In Missouri, you can only renew one payday loan six times. So, if you’re in a store and you’ve kind of worked that consumer for all you can get out of them and they still can’t pay – because that typically is what happens – then they’ll probably say something like, ‘Well, maybe you could take out another loan.’ And so then they’ll go to the store across the street, next door, or whatever; take out another loan to pay off that loan; and then the cost tend to snowball. It’s not unusual to see people with several thousand dollars in payday loan debt, and all they’ve done is pay interest up to that point.”
The Value of Payday Loans
Nevertheless, we can’t ignore the fact that payday loans occupy an important niche in the finance world. They’re available – albeit at a hefty price – when there’s no other credit to be had.
“There are people who know what they’re doing, and they [take out payday loans] because that’s the best option they have,” says Dr. Sugato Chakravarty, a professor of consumer economics at Purdue University. “It’s conditional rationality. But it might seem like irrational behavior to us watching from the outside.”
Sure, payday lenders can be both predatory and deceptive, but the products they’re hawking aren’t inherently evil and blowing up the entire market could end up doing more harm than good.
“Restricting payday lending may also bring unintended consequences,” Dr. Kelly Edmiston – a senior economist for the Federal Reserve Bank of Kansas City – wrote in a 2010 report. “It is important for policymakers to understand both the potential benefits of restricting payday lending as well as the potential costs.”
What kinds of costs are we talking here? Well, without the availability of payday loans, it figures that desperate borrowers could conceivably turn to loan sharks and other criminal elements to get the funds they need. We obviously don’t want that. The downfall of the payday lending market could also put a damper on economic growth via increased bankruptcy and default rates as well as higher social services costs for the poor and people in need of medical care.
So, where does that leave us? Well, it seems we must strike some sort of regulatory balance that makes predatory lending more difficult without restricting consumer access to needed loans.
“I think there’s a place for [payday loans] simply because there are a number of people who have no other access to short-term credit,” Edmiston told Card Hub. “Instead of banning them altogether – it’s not my view that we should ban them altogether until there are sufficient alternatives for people to get small-dollar loans who have no other access to credit – I think we can put some regulations in place.”
Edmiston recommends improved disclosures highlighting the true costs and expectations related to payday loans as well as education campaigns regarding the dangers of misuse.
Dr. Brian Melzer – an assistant professor of finance at Northwestern University who has done considerable research on payday loans – agrees, saying, “It does seem sensible to try to find that balance between prohibiting payday lending completely and allowing it, particularly for the cases where people are using the loans to their benefit – smoothing through short-term income or consumption” problems. He in turn recommends capping the number of payday loans a given consumer can take out and if the consumer happens to reach that limit, transitioning them into an extended payment plan.
Alternatives to Payday Loans
Various types of legislation aimed at payday loan regulation are currently in play, and Pew plans to release its own set of recommendations within the year. In the meantime, countless consumers will find the need for a payday loan, and since such loans are typically an option of last resort it’s fair to wonder what alternatives – if any – they’ll have. There are indeed some preferable options, including:
- Small traditional loans: If you have decent credit you might qualify for a traditional loan, which would certainly come with a much lower interest rate than a payday loan and offer a more reasonable repayment period.
- Employer paycheck advances: If you have a good relationship with your employer it might not hurt to at least ask for an advance on your paycheck. If you decide to go this route, make sure to have a good reason for needing the money now and be very careful to budget so that you won’t need another advance next pay period.
- Credit counseling: If you’re considering a payday loan to deal with unmanageable debt, try to work out a payment plan with your creditor first.
- Emergency assistance programs: Certain community and faith-based organizations offer financial assistance to people in need.
- Credit card cash advances: We certainly don’t recommend doing a cash advance if you can help it, as credit card issuers typically charge high fees and interest rates in excess of 20%. But even that is better than the 400% + rate you might get with a payday loan.
You can also take the following proactive steps to ensure that you won’t need an emergency loan in the future:
- Budget: Rank your monthly expenses in order of importance and eliminate those that would lead your expenses to exceed your after-tax income.
- Feed an emergency fund: You won’t have to seek an emergency loan if you already have some reserve funds earmarked for that purpose. We recommend a fund with about a year’s after-tax income.
- Use the Island Approach: You can lower the cost of existing debt and give yourself a built-in warning system for overspending by implementing the Island Approach.
Ultimately, a few things are clear when it comes to payday loans: they’re expensive, they’re marketed in a predatory manner, they’re desperately in need of regulation, and many people use them not as an emergency financial bridge but instead as a crutch to support an unsustainable lifestyle. So, the best advice is to avoid them if you can, and if you can’t, proceed with caution.