Payday Loans: A Choice That Virginia Consumers Need And Want
George C. Landrith
Payday loans are an important financial resource for Virginia consumers who may need immediate help paying unexpected and urgent expenses such as medical bills or car repairs. Banks and credit unions do not typically make these sorts of loans. Thus, payday loan services are needed and provide a significant benefit to consumers by expanding their choices and giving them greater ability to deal with unexpected or urgent needs.
The payday loan industry is regulated by the Bureau of Financial Institutions and only 43 consumer complaints were filed against payday lenders from among the 3.6 million loan transactions that were completed in 2006. The numbers for 2007 are similarly impressive. These impressive numbers makes one wonder what is the big push for greater government regulation? Moreover, the industry serves a customer base that is middle class, educated, employed and has a banking relationship.
Some consumer advocates and politicians argue that payday loans hurt consumers and should be effectively banned or strictly regulated. However, if we look at other states, we find that payday loans are helpful to consumers and provide them with needed options and choices. For example, a Federal Reserve Bank Staff Report released in November 2007, concluded that the absence of payday loans in Georgia and North Carolina left consumers without a reasonable credit option and often forced consumers to seek less favorable alternatives that often led to long-term financial problems. The report stated:
Compared with households in all other states, households in Georgia have bounced more checks, complained more to the Federal Trade Commission about lenders and debt collectors, and filed for Chapter 7 bankruptcy protection at a higher rate. North Carolina households have fared about the same.
Thus, it becomes clear that payday loans actually help consumers by giving them additional choices and options when dealing with urgent unexpected expenses. Those who want to limit or ban payday loans seem to assume that consumers are ignorant and cannot make choices that serve their best interests. Yet, the entire economy is based on the idea that consumers make rational choices and can pursue transactions that meet their unique needs. Regulations that require full disclosure so that consumers can make informed choices, make sense. Regulations that limit or effectively ban payday loans simply take choices and options away from consumers.
Banks, credit unions and other financial institutions have yet to offer a viable way to offer short-term credit like payday loans. The Federal Reserve Staff Report concluded: “Banning payday loans is not, by itself, going to motivate competitors to lower prices or invent new products.” Thus, banning payday loans will only close off options and choices for consumers and create more serious financial problems.
The Federal Reserve Staff Report also supports the idea that payday loans are a reasonable alternative to the costs and other adverse consequences that often follow cash flow problems. The report states, “[O]ur findings contradict the debt trap/addiction hypothesis against payday lending.” Additionally, the Report concluded that “[Payday loans] are consistent with the alternative hypothesis that payday credit is cheaper than the bounce “protection” that earns millions for credit unions and banks.”
A January 2007 Federal Reserve Bank of New York study, “Defining and Detecting Predatory Lending,” concludes that payday loans do not reduce the financial well-being of consumers. To the contrary, the authors of the study concluded that payday lenders enhance the welfare of households by increasing the supply of credit and giving consumers additional financial options. The report made the following points:
A payday cash loan “raises household welfare by providing a preferable alternative” and can help households “better manage their finances.”
Households that use payday loans “are less likely to have missed a debt payment over the previous year.”
Consumers are not ignorant or unsophisticated and like other credit and financial products, know the risks associated with payday advances. The Report noted that “despite their alleged naiveté, payday borrowers appear sophisticated enough to shop for lower prices.”
Another study conducted by Bretton Woods concluded that consumers in North Carolina paid approximately $652 million in non-sufficient funds and over-draft protection fees in 2006. These fees are often referred to as “bounced check” fees. Banks collected an estimated $538 million through such fees, according to the study. North Carolina’s credit unions — including the Durham-based Self Help Credit Union, which is affiliated with the Center for Responsible Lending — collected $114 million from their customers through such fees.
Interestingly, the Center for Responsible Lending argued that eliminating payday loans in North Carolina would save consumers about $93 million a year. But North Carolinian consumers paid more than six times that amount in so-called bounced check fees to banks and credit unions. Thus, it is clear that payday loans are a responsible and consumer friendly option compared to the options that banks and credit unions typically provide.
Other’s argue that the annualized interest rate on a payday loan is too high saying that it can reach more than 300%. (A payday loan of $100 would require a $15 fee when it is repaid in two weeks. If the $15 fee is multiplied 26 times to get to 56 weeks or one year so that the fee is “annualized,” that is how one gets to the high interest rate claims.) However, the loan is not for a year and it is repaid after two weeks.
Nonetheless, it is interesting to note that if the costs of a bounced check imposed by a bank or credit union are similarly annualized, the interest rate approaches 1000%. If one annualizes the late fee on a typical credit card bill, the interest rate exceeds 700%. If one annualizes the late fees and the reconnect fees for a typical utility service, the interest rate exceeds 1300%. And if the bounced check fees charged by a store or merchant are annualized, the interest rate would also exceed 1300%. The point is, a payday loan is a bargain in comparison to these financial options. Consumers are smart and understand this. This explains the popularity of payday loans to solve urgent, unexpected, short term cash flow problems.
Some have suggested that an interest rate cap of 36% should be imposed to bring payday loans in line with other lenders. However, payday loans are one of only three financial products that have any rate caps. Thus it is completely inaccurate to suggest that payday loans are somehow an overlooked financial product that need to be “brought into line” with other financial products.
It is interesting to note that car loans (which are secured loans) do not have a statutory rate cap. Nor do credit cards, student loans, bounced check fees, or ATM fees. If the 36% rule were imposed on payday loans, a $100 loan would be able to charge only a $1.38 fee. Banks typically charge more than that for a customer to simply withdraw the own money. How can anyone rationally suggest that is a reasonable fee to borrow money on an unsecured basis?
The truth is if consumer advocates want lower rates for consumers, they should encourage the growth of the payday loan industry so that there is ample competition which will drive costs to their lowest possible point. Government regulation rarely provides the cheapest cost or the highest quality service. But vibrant competition has proven time and again to be a consumer’s best friend – bringing both low prices and high quality goods and services.
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Frontiers of Freedom Institute was founded in 1994 by U.S. Senator Malcolm Wallop and is an educational institute (or think tank) whose mission is to promote conservative public policy based on the principles of individual freedom, peace through strength, limited government, free enterprise, and traditional American values as found in the Constitution and the Declaration of Independence. ###
Mr. Landrith is a graduate of the University of Virginia School of Law, where he was Business Editor of the Virginia Journal of Law and Politics. He had a successful law practice in business and litigation. In 1994 and 1996, Mr. Landrith was a candidate for the U.S. House of Representatives from Virginia's Fifth Congressional District. He served on the Albemarle County School Board. Mr. Landrith is an adjunct professor at the George Mason School of Law. He is recognized as an authority on constitutional law and jurisprudence, federalism, global warming, and property rights.
