Should the Payday Loan Industry be Allowed to Exist? Experts Weigh In.
In some circles, a payday cash advance is being proclaimed as one of the worst financial decisions that any American can make. Critics cite the high interest rates charged by the payday loan industry, the prevalence of low-income borrowers and the tendency of many borrowers to renew their loans or obtain multiple loans as evidence that the payday lending industry should be eradicated. Since its creation in 2011, the Consumer Financial Protection Bureau has been leading the attacks on payday loan companies, and the tough regulations proposed by the CFPB could — according to the agency’s own research — force many lenders out of business and make short-term, small-dollar loans much more difficult for borrowers to obtain. However, it is interesting to note that there is no agreement among the experts regarding whether the payday loan industry should be permitted to exist.
Experts Holding Opinions That the Payday Loan Industry Should Not Be Allowed to Exist
In addition to the CFPB, several other agencies have actively campaigned against both storefront and payday advance online loans. Two of the most vocal have been the Center for Responsible Lending and Americans for Financial Reform. However, an opinion piece posted on InsideSources.com raises the question of whether these two groups might have a vested interest in the destruction of the industry.
• The parent organization of the CRL is Self-Help Credit Union, leaving some people to wonder whether the CRL has at least a passing interest in eliminating potential competition for its parent organization. Furthermore, at least one highly placed CRL executive also serves on the CFPB’s advisory board; according to Christopher Kukla’s LinkedIn profile, he chairs the Consumer Lending Committee for the CFPB Consumer Advisory Board and is an executive vice-president at the CRL. The CRL has gone on record as supporting the proposed CFPB regulations, claiming that payday loans are debt traps and that lenders target minorities. In addition, the CRL supports capping the interest on these loans at 36 percent and opposes allowing banks to offer similar short-term loans.
• Americans for Financial Reform is not a single agency but a coalition of many state and national organizations. Members include the CRL, the AFL-CIO, the Communication Workers of America, MoveOn.org Political Action, the Progressive States Network and Consumer Watchdog. A quick review of the AFR’s steering committee shows that committee member Mike Calhoun is also the president of the CRL. According to the previously mentioned article from InsideSources, the AFR has strong ties to Sen. Elizabeth Warren, the leading force behind the creation of the CFPB. The coalition is supported by progressive donors and labor unions, and the primary goal of the AFR is the advancement of progressive issues at the grass-roots level. How the AFR feels about payday lenders is perhaps best illustrated by its hostile, aggressive campaign against Rep. Debbie Wasserman Schultz of Florida over a bill she co-sponsored that would delay the CFPB regulations for approximately two years.
Interestingly, economists and financial analysts find the issue of cash advance loans far more ambiguous than the consumer watchdog groups and government agencies. According to Journalist’s Resource, one study showed that access to payday cash advance loans were beneficial after natural disasters or other extreme misfortune, but also found that the loans encouraged borrowers to overspend. Another study found that payday loans had a negative impact on the retention and job performance of members of the U.S. Air Force. A study conducted to assess the impact on consumers in Georgia following the state’s ban on payday cash advance loans found that the lack of access to these loans hurt consumers’ ability to pay their other debts.
Experts Defending the Payday Cash Advance Industry
Although most of the media attention in recent years has been focused on local payday lenders and lenders who make online payday advance loans, a number of economists, researchers and financial analysts have been less willing to vilify the industry. Many experts have stated that the popularity of cash advance loans indicates that the industry supplies a valuable product for borrowers who have limited access to traditional credit and are living from one paycheck to the next. Without savings, credit cards, relatives who are financially stable or the credit histories required to get a loan from traditional lenders, these borrowers are faced with few options when a financial crisis arises — and in many cases, the fees for a payday loan may be less than the fees that the borrower might otherwise incur.
For example, many borrowers are renters rather than homeowners, and an apartment complex or landlord can charge a hefty fee if rent is paid late. The fee charged by a bank for one check returned due to insufficient funds can exceed the cost of a cash advance, and several small checks that get returned can be a financial disaster for many people. If a utility is disconnected, the reconnection fee can be much more than the fee charged by payday lenders; the utility company might also require an additional deposit.
Although it might surprise some people, the Federal Reserve Board has published numerous papers showing that payday lenders are not the evil, greedy, exploitative opportunists that the CFPB and other agencies portray.
• In 2013, Neil Bhutta of the Board of Governors of the Federal Reserve Board in Washington, D.C., wrote that his research had found little or no effect on new delinquencies, credit scores or overdrawn credit lines as the result of payday loans. In other words, there was no link found between borrowers’ financial health and cash advance loans. Furthermore, his study found that payday lenders chose locations based on the economic conditions of the neighborhood, disproving claims that these lenders targeted minority neighborhoods.
• A senior economist at the Federal Reserve Bank of Kansas City analyzed the results of numerous studies to determine whether restricting payday lending would hurt consumers. The analysis found that restrictions would force some consumers to seek alternatives that would be more expensive, limit these people’s ability to maintain their formal credit standing and/or deny them access to credit.
• An article appearing on the Federal Reserve Bank of New York’s blog reported that the fees charged by payday lenders were largely justified due to the high default rates and operating costs. The authors also took exception with those groups advocating a cap of 36 percent, recommending that they reconsider unless they want to eliminate all such loans.
Other well-respected financial experts have also recommended that the CFPB proceed cautiously. For example, William Isaac is a former chairperson of the Federal Deposit Insurance Corporation. In an opinion piece appearing on AmericanBanker.com, Isaac expresses his concern about the unintended consequences that excessively regulating payday lenders could have on the very people that the CFPB and other groups claim to be protecting. In a paper published by Reason Foundation, Adam B. Summers states that the evidence shows that most of the criticism is based on myths and that payday lending can provide many borrowers with a number of benefits.
Experts Examine Results in States Banning Payday Loans
In response to the criticism leveled at payday lenders, many states have passed laws regulating or even abolishing them. Two researchers at the University of Washington examined the effects that regulations and price caps had in states limiting short-term lending.
• Capping interest rates at 36 percent or less resulted in a significant decrease in the supply of cash advance loans. Although the researchers found that it is difficult to determine the precise number of lenders — other than those offering online cash advances — operating within a given state, they stated that it is unlikely that there are any lenders operating storefront sites in states that do not allow interest rates above 36 percent.
• Many borrowers had no alternatives available. A survey of cash advance borrowers conducted prior to Oregon’s capping of interest rates found that up to 70 percent of borrowers stated that they had no alternative for short-term credit. The concern was that some borrowers were turning to pawnbrokers, paying bills late and bouncing checks, which can be even more expensive and financially destabilizing than cash advance loans.
• The researchers found some evidence suggesting that regulating payday lenders out of business caused financial hardship in many households. In North Carolina and Georgia, bankruptcy filings and bounced checks increased after the industry was effectively regulated out of existence. In Oregon, many borrowers reported that their financial situation deteriorated after interest rates were capped. However, the authors felt that the evidence was too incomplete and inconclusive to demonstrate any inarguable links.
Researchers at Cornell University drew on reports from the FDIC, the Federal Reserve Bank of New York and various other studies to determine the effect that banning cash advance loans had on consumers. Financial security, the use of alternative financial services and the use of traditional credit products were some of the categories analyzed for states that had banned cash advance loans altogether, capped interest rates or otherwise restricted the ability of consumers to access online payday advance or traditional cash advance loans. The report presents some of additional information about what has happened soon after individual states have chosen to regulate payday lenders.
• Evidence from various states shows an overall increase in bounced checks following a ban on payday lending. At the same time, banks reported an increase in income from overdraft fees as well as more returned checks.
• Not surprisingly, the volume of loans fell in states banning lenders from operating physical stores, but the decline was shown in several states that still allowed online payday advance loans.
• Restrictions on payday loans led to an increase in the number of consumers borrowing from pawnbrokers. In states with bans, the mean usage rate showed a 60 percent increase from the rate in states allowing cash advance loans.
• In states banning cash advance loans, involuntary closures of checking accounts increased by 0.2 percent. Most involuntary closures are the result of overdrafts or bounced checks.
• The use of traditional credit products did not increase following a ban. Instead, the use of traditional credit products actually decreased slightly among people with low credit scores. The reasons are unclear, but the researchers suggest that one theory is that people who have their accounts involuntarily closed might also lose any credit cards associated with those accounts.
How Borrowers Feel About Payday Loans
Ultimately, the true picture of the payday lending industry must include more than just the opinions of experts at watchdog groups, people who have never used the product, political appointees and groups that are in competition with payday lenders. The best evidence for or against payday lenders comes from borrowers who have used short-term, small-dollar loans.
• Pew Charitable Trusts, a long-time opponent of the payday lending industry, was likely chagrined after interviewing approximately 700 borrowers. Approximately 62 percent stated they would be likely to take out another loan, 48 percent said that cash advance loans help more than they hurt and over 50 percent reported that the loans relieved stress when facing the need for quick cash.
• A poll conducted by Harris Interactive Public Relations Research found that 95 percent valued having payday loans as an option, 68 percent believed that their financial conditions would be worse without the ability to take out a loan and 89 percent felt the loans were worth the cost to avoid incurring late charges on bills.
• The same poll revealed that 98 percent indicated they were satisfied with their experience, 97 percent said that the overall experience was as expected or better than expected, 65 percent would recommend payday lending to friends or relatives, 80 percent said they would be likely or very likely to take out another loan from the same lender and 95 percent did not want the government to interfere with their use of payday loans. Furthermore, borrowers gave extremely high marks to their lender’s honesty, respectful attitude, knowledge and trustworthiness, and 97 percent reported that the lender explained the loan terms clearly.
• The CFPB asked for comments on the agency’s proposed regulations, but it did not release the results until forced to do so by requests made under the Freedom of Information Act. Over 98 percent of the comments were positive. Furthermore, the CFPB admits that complaints about the payday lending industry have been few.
No Simple Solutions to a Complex Issue
The debate over whether the payday lending industry should be allowed to exist will likely continue for some time. Experts, borrowers and analysts will continue to weigh in on both sides of this complicated issues. There are no simple solutions, and there is no single solution that will be supported by the agencies, individuals and experts on both sides.