Predatory lending has been a hot button issue for the last ten years or so – especially since the financial crisis of the mid oughts. Stories of perpetual payments, families rendered homeless by parasitic schedules, and greater than 100% annual interest rates abound. Legislation has been quick to follow regulating or outlawing these establishments, and their proprietors have been branded the pariahs of the financial industry.
But the truth is, payday lenders are a valuable last resort to America’s poor. They offer an emergency solution to repair a child’s glasses so she can read at school, to fix a car quickly so one can make it to work, to make an sudden appliance repair so that everyone can wear clean clothes, or any number of other family emergencies.
Payday lenders charge exorbitant interest rates by mortgage loan standards, but they are not unreasonable by banking fee standards. Imagine the scenario where a mother needs to find 100 dollars to fix her child’s glasses. The darned kid should have been more careful with them, and now mom is in a tough spot, but kids are kids and these things happen. The local payday lending shop will lend her $100 dollars today but wants $110 in return next Friday which is the mother’s pay day. I think most of us would think this sounds like a reasonable agreement. We are occasionally willing to pay a $5 ATM fee for a $100 withdrawal – and that is getting the money from our own account. Paying twice that to have it lent for a week in an emergency situation seems acceptable.
But in order to compare that loan to those available in other situations requires that we look at that fee annualized – in order to compare apples to apples. When viewed through this lens, the annualized interest rate on this loan is 560%. That looks predatory, mean spirited and downright unfair. For comparison, this is about 100 times the rate of most home equity loans.
It is because of this comparison, that legislators and activists are quick to attack the payday loan industry. Recent regulations require that they cannot occupy locations in poor neighborhoods, cannot charge more than a certain interest rate, or must close their doors altogether. Forcing these operators out of the neighborhoods they serve simply increases the cost to borrowers who now have to travel or take time off of work to secure their loan. Capping interest rates forces the operators to increase transaction fees (so the end payment is the same) or stop offering certain types of risky loans. And forcing lenders to close their doors means that needed loans can’t possibly be made. Does anyone actually believe that people are better off having the last resort option taken off the table?
Now, there are real problems within this industry. There are borrowers who do not pay their loans on time and find themselves in trouble quickly. At these rates, a $100 loan can turn into a $200 debt in a couple months or thousands if let go for too long. Some borrowers may be borrowing for non-emergency situations such as entertainment, frivolous purchases, or drugs. Still others may not understand the math behind what they are signing up for. And finally, there are operators who are truly awful. But all of these are exceptions and and can be managed down to acceptable levels by smart legislation and good operators. At the end of the day, so-called predatory loan operators are offering opportunities to poor communities that have no access other financial solutions.
There is another issue here which revolves around the concept of “fair.” When someone is in financial trouble and facing penalties they often claim it is unfair, even if they are in that spot as a result of their own doing. Society is sympathetic to this argument and often makes excuses for them such as they were taken advantage of, they didn’t know what they were getting themselves into, or the lender made it too complicated (which is another way of saying the borrower is too stupid). There may be legislation required to ensure that things are clear, but people taking responsibility for their own finances is one of the costs of taking out a loan. No honest person borrows money without expecting to pay it back when they say they will (or face consequences).
Be wary when the mob with pitchforks tries to kill the monster by burning down the windmill, as they are often hiding the larger issue. Community banks have been driven out of poor neighborhoods due to 20 years of well-meaning but over-bearing regulation. In their absence payday lenders should be welcomed, nurtured, and regularly reviewed.