A Look at Payday Loans
Payday loans
appear to be growing in importance. The spam folder in my
email register now seems to have as many solicitations for
payday loans as for home mortgage loans. The internet is a
more cost-effective way of marketing payday loans than the
traditional storefront. In addition, a number of banks have
entered the market in recent years with “deposit advances”
which are
essentially the same as payday loans.
Payday loans including deposit advances are small loans
generally in the $150-$400 range, repayable in a few weeks
when the borrower is due to receive a paycheck or some other
scheduled payment. The loan is designed to tide the borrower
over until the payment is received. The cost of a loan is
usually $15 to $20 for each $100 borrowed, regardless of
whether repayment is due in one week, two weeks, or 4 weeks.
Payday loans are convenient, quick, and readily available
without a credit assessment. To assure repayment, borrowers
provide lenders with direct access to their deposit account;
in effect, borrowers authorize lenders to repay themselves
from the borrower’s account.
Payday loans have been much criticized for
their interest rates which, on an annual basis can run 400%
or higher. However, high interest rates are not really the
problem. Since the cost to lenders of making a small loan is
much the same as the cost of making a large loan, high rates
on small loans are unavoidable. The real problem is not that
payday loans are costly but that they are potentially
addictive.
Payday loans remind me of an episode I had some years ago
with morphine. I had a neck ailment that required that I lay
motionless on my back for two days. To make the process as
painless as possible, my physician prescribed morphine,
which worked like a charm. I enjoyed my two days in a
euphoric stupor.
When the two days were over, my neck was
better but my euphoria was gone and I missed it. I didn’t
bother asking for a refill, however, because I knew the
physician would say no. and in any case I had no desire to
become addicted. My life proceeded without any more
morphine.
Payday loans can be useful, just like
morphine, if used occasionally to meet unexpected
contingencies. But if the need for the loan arises from a
persistent gap between the borrower’s income and
expenditures, the loan will not eliminate the gap. Indeed,
the ease with which the cash is obtained may discourage the
borrower from making the changes in spending practices that
are needed. The borrower becomes addicted to payday loans.
This evidently is more the rule than the
exception. The newly created Consumer Financial Protection
Bureau (CFPB) now administers the array of consumer
protection laws that apply to payday loans. A recent study
by the agency showed that among a sample of payday
borrowers, only 13% had 1 or 2 transactions during the
12-month period covered by the study. 39% of the borrowers
had 3 to 10 transactions, and 48% had 11 or more
transactions. The median number of transactions during the
year was 10.
The frequent borrowers account for a
disproportionate share of loan fees paid to lenders. The 48%
of borrowers who had 11 or more transactions produced 75% of
the fees. The frequent borrowers accounted for an even
larger part of lender profits because the marketing expenses
of payday lenders is focused on getting new clients. For the
most part, repeat borrowers require no salesmanship.
There is no one connected to the payday
loan market who has an interest in helping the borrower deal
with an occasional fund shortfall while preventing him from
becoming a payday loan junkie – the role played by the
physician who treated me for a bad neck. Payday lenders
certainly can’t play that role because they make most of
their money from payday junkies. The CFPB is on the
borrower’s side but the focus of the various statutes it
enforces is protecting borrowers against abuses by lenders
and others. To my knowledge, it has no authority to help
borrowers avoid abusing themselves, which is the core
problem.