Should "Payday Loans" Be Outlawed?
State Senator Roderick D. Wright (D | 8/29/2010, 10:37 a.m.
Over the years I've seen many articles critical of the short-term financial product commonly known as a "Payday Loan." They have been termed abusive for their high interest rates and the fact that people often have multiple loans and fall into greater debt. I don't challenge the fact that more of these loans go into default, it speaks to a larger problem.
Where do people with credit issues get emergency cash? I have never seen any of those articles critical of payday loans offering real solutions.
The public must understand something about the "Payday Loan" industry. They are providing loans to people traditional financial institutions cannot, or will not serve. Often their customers have exhausted their credit, their friends and family and all other sources of less expensive cash. They typically have an immediate need and the vast majority of these borrowers repay their loans on time.
Assuming the loan is repaid on time the fees are not much higher than those of a traditional bank. Depending on the amount of the loan, when measured against bank fees for a bounced check, the payday loan could actually be less expensive than a bank!
From a business standpoint, the payday lender assumes a much greater risk than a regular lender in that this is an unsecured loan to a person with admittedly bad credit. Just as a traditional bank determines the interest rate it charges based on the customer's credit score -- a risk assessment -- the payday lender does the same thing.
With a lower credit score, your interest rate at a bank can more than double. Most payday loan customers would not qualify for even the higher priced loan at a traditional institution. Let's not forget it was traditional banks that made virtually all the sub-prime real estate loans to many borrowers eligible for a better rate!
What options would be available to this customer if the payday lender is driven out of business? They could sell or pawn their possessions for a fraction of their value. They could seek out a loan shark and assume the repayment risk that comes with that. If you think a payday loan is expensive try defaulting on a loan shark!
Maybe they could just live with their utilities turned off or miss a critical medical appointment until they get the cash. In a worst case scenario, they may commit a crime and risk prison time. Against this set of options the payday loan starts to look pretty good.
There are entire communities without a local bank. I don't think anyone would argue that payday loans are not more expensive, or even that they are the desired way to get a loan. This would be true of any hard-money loan. The fact is payday lenders incur greater risk than the other lenders which is why their cost is higher.
Traditional lenders don't want any part of this market, even though every payday loan customer has a traditional banking account. You typically write a post-dated check to get a payday loan.
Many of the so-called consumer groups concerned about the poor would like to see this entire business model outlawed. Or they would like to make the interest rates payday lenders could charge comparable to those of traditional banks without considering the risk differential.
This would have the effect of driving payday lenders out of business. Payday lenders are not traditional banks nor do they serve the same customers. If payday lenders are forced out of business, the need for these services does not go away. Considering the options available in many instances, the payday loan is actually a bargain.
If someone has a better option for those in need of a payday loan let's hear it. If we can require traditional banks to offer payday loans at "fair rates" to those with credit problems, let's do it.
Traditional banks are allowed to hold government deposits where they pay minimal interest rates and make a sizeable profit. And as we have seen if the traditional bank makes a bad decision the government bails them out. So if those concerned offer no solutions, don't close the door on the last hope for those locked out. While the poor and credit-challenged appreciate your sympathy, if you can't help, don't hurt.
Roderick D. Wright is a state senator representing the 25th District of California