By Chris | February 18, 2008
I didn’t get my first credit card until I was 22 years old. Up until that point, I had no need for one. I had adequate savings and paid for most of my expenses with scholarship money and part-time jobs. However, when my savings dwindled I wanted some credit in case of emergency. It was surprisingly difficult to get a credit card. I had moved 3 times in the last year and had no credit history. I endured rejection after rejection until Bank of America gave me the opportunity to pay a 70 dollar annual fee for the privilege of paying them interest. I was thrilled.
So, I can understand why the payday loan industry thrives. There aren’t a lot of other options for low income people with poor credit. In my hometown of 50,000 people, there were no fewer than 11 payday loan companies on the main strip. If you can’t find one locally, you can even get an online payday loan. Most companies offer first time lenders a free 2-week loan. Subsequent loans are offered at a flat fee of anywhere from 15-30 dollars per 100 dollars borrowed. Critics blast the industry for its “predatory” lending practices. The United States government prevents lenders from charging members of the military more than 36% APR, effectively making payday loans to those in the military illegal.
I think it is sad that many people in America live paycheck to paycheck. But, I don’t blame the payday loan industry. The homogeneous nature of loans, the shear number of lenders, and non-existent barriers to entry in the industry make it a textbook competitive market. Fees are so high because the loans are incredibly risky. Borrowers are required to have a job and an identity, but not much else. Most loans aren’t backed by any collateral.
Muhammad Yunus won the Nobel Peace prize for lending small amounts of money to the world’s poor. Microfinance APR’s range from 30-70 percent (military personnel need not apply). Microfinance interest rates are high by our standards, but the alternative is much worse for entrepreneurs in desperate need of capital. Of course, Microfinance is not analogous to payday loans. Payday loans are very short term. They don’t fund business ventures, but alleviate the pains of liquidity crunches for poor Americans. It is not appropriate to blast the industry for annual percentage rates that hover around 500%; people aren’t taking these loans out for a year. No one complains about the 2000% APR on an ATM fee. When people pay 60 bucks for a 300 dollar advance, they aren’t buying a loan. They are paying 60 bucks to avoid the shame and consequences of defaulting on immediate financial obligations.
Most payday borrowers aren’t financially responsible. But their financial woes did not begin when they got their first payday advance. In a world where families are broken, children don’t get an education and there is enormous social pressure to look successful, people will mismanage their money. Payday loans are viewed with repugnance because they remind us of the sad state of those struggling financially. Eliminating these unpleasant signs might make us a feel a little better, but it will only remove the least unpleasant alternative for those those in the worst financial shape.
While reading up about this post I came across two interesting pieces of research:
Strategic Pricing of Payday Loans (Examines whether regulatory price ceilings facilitate implicit collusion)
Defining and Detecting Payday Lending (Examines whether lending is predatory)
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