Inside Financial Services

Payday Loans Really Do Serve a Useful Purpose

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Researchers at the New York Fed do a meta-analysis regarding payday lending, and wonder what all the handwringing is about:

Except for the ten to twelve million people who use them every year, just about everybody hates payday loans. Their detractors include many law professors, consumer advocates, members of the clergy, journalists, policymakers, and even the President! But is all the enmity justified? We show that many elements of the payday lending critique—their “unconscionable” and “spiraling” fees and their “targeting” of minorities—don’t hold up under scrutiny and the weight of evidence. After dispensing with those wrong reasons to object to payday lenders, we focus on a possible right reason: the tendency for some borrowers to roll over loans repeatedly. The key question here is whether the borrowers prone to rollovers are systematically overoptimistic about how quickly they will repay their loan. After reviewing the limited and mixed evidence on that point, we conclude that more research on the causes and consequences of rollovers should come before any wholesale reforms of payday credit. [Emph. added]

This makes total sense. Payday loans’ detractors seem to want to willfully ignore an unpleasant fact of life among low-income consumers: that from time to time those consumers need to come up with cash quickly to make an urgent payment—on a car loan, say, to avoid repossession, or an unexpected heath care expense. The fees the consumer pays on the loan may seem high, but the alternative, missing the payment, is much, much worse. As the study’s authors point out, the payday lending business is highly competitive; the fees lenders charge are determined by the market, not by greedy lenders’ malevolence. Further, the alternatives to payday loans, most notably pawn shops and bank overdrafts, also have high dollar costs and are (in the case of bounced checks, anyway) technically illegal. How’s that an improvement?

So the data shows clearly that payday loans provide a real benefit to the people who use them. This shouldn’t come as a surprise to people who understand how the world works. But it will of course count for nothing in the banking-scold community. To the scolds, lenders are almost always predatory and unscrupulous–whether the loan at issue is a payday loan, a credit card’s line of credit, a subprime mortgage, or some other kind of consumer loan. Unfortunately, the “solutions” the scolds tend to propose—in the form of the CARD Act, say, or qualified-mortgage rules, tend to make credit less available and more expensive than it would otherwise be, and so hurt consumers rather than help them. Guess what? Regulatory restrictions imposed on payday lenders will almost certainly have a similar effect.

What do you think? Let me know!


5 Responses to “Payday Loans Really Do Serve a Useful Purpose”

  1. JimBob

    When you go on the emotion of the cause and not the analysis of the situation, you get the reaction that most government officials have shown. Then, more importantly, you get the laws which always have unintended consequences and in most cases, do more harm than good.

  2. Dale Brandser

    If they weren’t needed, they would go out of business.

  3. WallStreetCritic

    Sure Payday lenders serve a purpose, but do the interest rates have to be so high?

    • Michael

      When you look at the expense of servicing a small loan portfolio and the high rate of defaults, the rates don’t seem so high. It is a competitive business and if it could be done cheaper and stay profitable it would be done.

  4. Ron Shevlin

    Totally agree. Payday bashers ignore the fact that most payday borrowers CHOOSE to get these loans, and use the money for critical reasons.

    The bashers also tend to ignore some facts (yes, facts, based on market research conducted on behalf of Chase Blueprint in 2013) about payday borrowers:

    1) ) Payday loan borrowers are not low-income consumers. Among consumers who took out a payday loan in 2012, 38% earn more than $70k per year, 32% earn between $30k and $70k, and just 30% earn less than $30k.

    2) Payday loan borrowers borrow from many sources. In 2012, seven in 10 payday loan borrowers borrowed from friends or family, a little more than half of payday loan borrowers took out a direct deposit advance and a small loan from their bank or credit union in 2012, 55% borrowed from a pawn shop in 2012, and 43% borrowed from a loan shark.

    It’s probably not a very kind or tactful analogy, but payday loan borrowers are like drug addicts–they have a problem. Going after payday lenders is like shutting down the small neighborhood drug dealer. That might it make it more difficult for the drug addict to get his fix, but does absolutely nothing to address the problem.

    Shutting down payday lenders only results in forcing these consumers to find other sources of money. Sources like friends and family who are likely tired of lending to these people, banks and credit unions who may be likely to turn them down for loans, and loan sharks who are hardly a better alternative to the often-regulated payday lending industry.

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