Comedian Sarah Silverman performed in a skit about payday loans for “Last Week Tonight with John Oliver.” While in character, she said, “If you’re considering taking out a payday loan, I’d like to tell you about a great alternative. It’s called ‘Anything Else’.” This statement certainly highlights the negative feelings that people have about the industry, but payday loans are often a good thing. They provide credit to a segment of the American population that has been shunned by traditional banks.
Payday Loans are Often Good, but They Have a Dark Side
The Pacific Standard points out that there are few feasible borrowing options for low-income individuals. However, the proof regarding the benefits of payday loans is unequivocally mixed. Research shows that payday loans result in a variety of economic struggles. Borrowers are sometimes unable to make their mortgage payments or cover other bills. Personal bankruptcy filings increase, and some payday loan borrowers need more government aid.
Other research shows that access to payday loans decreases foreclosure rates in areas struck by natural disasters. In addition, when short-term loan regulation is put in place, people bounce more checks while overall financial conditions often decline.
Payday Loans are a Contradiction
The Federal Reserve’s Christine Dobridge published a paper suggesting that payday loans are a contradiction since they can be helpful and harmful. She points out that when people have access to payday loans, households receive support when times of financial distress occurs. However, the opposite happens when people who aren’t suffering from unexpected financial problems decide to take out short-term loans.
Developing the Payday Loan Theory
To develop her theory, Dobridge compared household expenditures within different kinds of households. She discovered that after an extreme weather event like a hurricane or a tornado, households with access to short-term loans were able to cover home repairs, food expenses and mortgage payments. She also found that households that didn’t have access to payday loans had less to spend on monthly necessities.
Dobridge ultimately discovered that payday loans provide the service that the industry claims they do when they are used to offset the added expenses that arise during the aftermath of a financial shock. These loans give low-income families a way to rebuild their lives without forgoing food or other needs.
The story of payday loans changes when people use them during average financial moments. If a borrower owes money to a payday loan company during regular financial times, then he or she has less money for necessities because of the debt that is owed. Dobridge’s research confirmed that this is when payday loan critics are right. Borrowers who take out payday loans during normal financial times are often trapped in a cycle of debt that has high interest rates and fees.
Avoiding the Demand Side of Payday Loans
In the past, when officials held debates about payday loans, the arguments usually focused on the supply side of them instead of on the demand side that involves borrowers. The New Yorker reports that more research is being done from the point of view of those who take out these kinds of loans. Research has already determined that borrowers seek out short-term loans because of unexpected expenses 32 percent of the time. Policy suggestions almost exclusively focus on regulating the industry instead of making changes that would help people avoid the need for fast cash.
Modest Reforms Might Be a Win-Win Situation
Instead of transforming the payday loan industry or shutting it down, modest reforms may be a better solution. With smart regulation, officials could improve the business for consumers and lenders. The Atlantic published a story about payday loan regulations. In the story, the news source mentioned that Colorado officials reformed the industry in their state by decreasing the permissible fees and extending the minimum loan term to six months. The state’s reforms also included the requirement that borrowers could repay loans over time instead of forcing people to pay them off all at once in two weeks.
Some payday loan stores closed in Colorado, but each one that stayed open saw its customer volume rise. Today, those who borrow are paying 42 percent less in fees. Defaults are also down.
Low-Income Americans Have Limited Borrowing Options
The payday loan industry is right about low-income people having few borrowing choices. When it comes to borrowing money, these Americans are stuck. If family members or friends are unable to help out, then financially strapped people have nowhere else to go besides payday loan lenders. If the government wants to eliminate these kinds of loans, it must create new borrowing options. To read more about the good side of the payday loan industry, visit the PersonalMoneyStore.