Why Do Some States Outlaw Payday Lending?
When used responsibly, payday loans can provide a way to meet unexpected expenses, make sure that bills are paid on time or prevent overdrafts and associated bank fees. Several states, however, have banned payday loans, and other states have enacted laws that regulate the amount a consumer may borrow and how often. Typically, the states that have outlawed payday lending claim that they do so to protect their citizens, citing the fees charged, the difficulty that borrowers may have in repaying the loan and the disproportionate number of low-income borrowers.
Why States Outlaw Payday Lending – Fees and Interest Rates
Payday lenders charge fees that typically range between $15 and $30 for every $100 borrowed. When annualized, the effective APR can be 400 percent or more. Although it is true that the APR is substantially higher than the rate charged on a credit card, mortgage or auto loan, payday loans are supposed to be short-term agreements with the borrower paying off the loan by its initial due date. Some state legislators ignore the “short-term” aspect of payday loans and, based on the effective APR, consider the fees charged by lenders to be usurious.
Many states have laws that dictate the maximum annualized interest rate that lenders can charge, and rates exceeding that maximum may be considered usurious. These maximum rates can range between 5 percent and 24 percent with most states setting the limit between 10 and 15 percent. However, banks, pawnbrokers and some other small lenders, such as “buy-here, pay-here” used car dealers, are exempt from the usury laws.
In some states, the legislature has decided that payday lenders do not qualify for exemption under the usury laws. Interestingly, if the same rationale is applied to late payment fees or returned check charges, the equivalent APR would be three to four times higher than the rate for a payday loan. For example, a check for $100 returned by a bank that charges $32 for a check returned due to insufficient funds would yield an APR of 2,336 percent.
Loan Repayment Difficulties
Some state legislators have expressed concern that borrowers may have difficulty repaying their payday loan. As they are by definition short term lending, borrowers may find themselves unable to pay the loan and associated fees by the specified due date. Borrowers may feel forced to choose between paying off the loan and paying for necessities, such as groceries, medications or rent. Alternatively, borrowers may renew the loan by paying just the interest, a practice that legislators feel could keep the borrower in debt for an extended period at a high cost.
Lending to Low-Income Borrowers
Another objection that is frequently voiced by legislators is that borrowers who seek payday loans have below-average incomes. Payday lenders have been accused of targeting those with low incomes and taking advantage of their vulnerability. However, a study conducted by The Texas Tribune paints a slightly different picture. Although the study found that payday lenders tended to place their businesses in neighborhoods where the average annual income was below $50,000, a limited number were also found in more affluent neighborhoods with incomes averaging $100,000 or more.
Typically, however, the greater the income, the greater the likelihood that borrowers would be able to choose from a variety of options, such as withdrawing money from savings or using a credit card to pay for unexpected expenses. People with lower incomes might not have alternatives to payday lenders if faced with a financial emergency. Since people typically prefer to conduct business at a convenient location that is near their home, it would seem logical for payday lenders to place their physical stores in the neighborhoods of their most likely customers.
Outlawing Payday Loans is State Paternalism
In an opinion piece appearing in The Christian Science Monitor, writer Tim Miller described attempts to ban payday loans as the government’s notion that adults had to be legislatively protected as they could not take care of themselves. Miller opposes the “paternalistic rhetoric” that has surrounded laws to prohibit or control payday lending. He also notes that such laws cause the most economic harm to those who would be most likely to use the service. For support, Miller cites a study conducted by the Federal Reserve Bank of New York that found that after Georgia banned payday loans, the state recorded a 9-percent increase in Chapter 7 bankruptcies while fees collected for bounced checks increased $36 million.