Payday Loans in America: A Brief Historical Overview
The payday loans industry evolved naturally in the United States as a result of deregulation, market forces, stricter FICO guidelines and the rise of Internet lending. An article at Loannow.com suggests that some form of the payday loan has been around since ancient times and includes loan sharks, personal lenders, store credit, bar tabs and pawnshop lending. The Consumer Federation of America reported that predatory lenders in the United States charged interest rates as high as 1,000 percent during the Great Depression.
The payday loan industry, as it exists today, came into force as the result of two legal actions in 1978 and 1980. The Supreme Court ruled that national banks could charge interest rates based on their own state laws instead of charging interest based on the laws of states where borrowers lived according to a report at Findlawimages.com. The ruling, which was a result of Marquette National Bank vs. First of Omaha Service Corporation, enabled payday lenders to open brick-and-mortar stores in states where the laws were friendly.
The Depository Institutions Deregulation and Monetary Control Act of 1980 allowed banks and lenders to charge interest rates based on supply-and-demand. Deregulation opened the floodgates to all types of alternative lending, which triggered the payday loan industry. Brick-and-mortar stores grew rapidly by offering check-cashing services, paycheck loans and automobile title loans. Installment loans and online loans became popular as Internet use grew astonishingly fast in the late 1990s and early 2000s.
The History of the Payday Loan Industry in the United States Arose from Past Abuses by Traditional and Predatory Lenders
The payday loan industry rapidly became a target of consumer-oriented groups because many borrowers became trapped in cycles of debt. Unfortunately, some people borrow many times to cover previous loans, so they get caught in ever-escalating debts. However, the same is true of any kind of credit when it’s used irresponsibly. Payday lending–when used as intended–helps people to cover unexpected expenses and prevent service disconnections, late fees and penalties.
Some lenders offered a type of payday advance loan about 100 years ago, and these lenders were known as “salary lenders” according to an article at Pewtrusts.org. These lenders charge rates as high as 500 percent for a one-week loan, which were less than some payday companies charged. However, the default rates were lower because these illegal lenders used physical threats, wage garnishments, extortion and public embarrassment to collect their money. Legal payday loans were offered as an alternative to these lending excesses of past generations. Payday lenders generally offer legal and safe loans even when borrowers can’t repay their obligations.
The Roots of Payday Advances Include Small Shopkeepers Extending Credit Until Payday
Other types of payday advances have always been common in the United States. It’s been quite common for neighborhood businesses to offer store credit for essentials like food and nonessentials like alcohol. Well-known customers could open a tab based on repaying their obligations on the next payday. Many of these lenders used this tactic to ensure that customers would return to them to buy necessities, so the interest rate wasn’t an important factor.
The Shift to Payday Advance Loans Grew from FICO Scores
Payday advance loans became extremely popular because many working people were marginalized because of low credit ratings, or FICO scores. The Federal National Mortgage Association (Fannie Mae) and Freddie Mac began using FICO scores in 1955 to determine whether to finance mortgages according posted at Selflender.com. The practice spread to other types of lending by 1959.
Unfortunately, this practice depersonalized lending to a large degree. The immense expansion of business and consumer goods and the introduction of credit cards shifted loan approvals from granting credit based on personal knowledge of the borrowers and their family ties to studying impersonal financial data. This trend grew even more pronounced when computer lending and electronic data became prevalent after Quicken Loans sped up the approval process for mortgages in the mid-1980s. Internet banking was introduced in 1999 when the First Internet Bank came online.
Paycheck Loans Join the List of Alternative Lending Options for Consumers
Paycheck loans–which were designed as an alternative for people who can’t get fast loans for various reasons–were never meant to be options for long-term financing. However, as in any industry, abuses have occurred. Many state legislatures and the federal government have passed a series of laws to curb the worst abuses and to allow banks and other lenders to cap interest rates based on where they’re located instead of where they lend the money.
An article posted by Academyfinancial.org reports that payday lenders originally served borrowers with lower incomes and those from poorer neighborhoods. These borrowers don’t have access to traditional loans and credit cards because of income limitations, poor credit ratings or a lack of neighborhood banks where they live. As the popularity of paycheck loans grew, families with high consumer debt–even those with higher incomes–found that a payday loan could come in handy when their ready cash couldn’t cover an unexpected expense.
The report actually favors the payday loan industry as a reasonable alternative because most payday lenders are relatively small businesses when compared to banks, major retailers and electronics manufacturers. The following issues support the organization’s thoughts on paycheck loans:
- Operating costs of a brick-and-mortar payday loan store run between 70 percent and 80 percent.
- Loan default rates for payday advance loans are higher than those of other financial products.
- The payday loan industry has experienced tremendous growth, which shows that it’s popular with consumers.
- Unlike some predatory lenders, companies that offer paycheck loans generally comply with legal requirements.
Alternative Lending Practices Become More Common While the Fight Over Payday Lending Intensifies
The Pew Trusts article identified escalating state regulations and the Talent Amendment of the Defense Authorization Bill of 2007 as major steps in opposing paycheck advance excesses. The bill capped interest rates for military families at 36 percent. The excesses of traditional lenders that triggered the financial crisis of 2008 resulted in the Dodd-Frank Wall Street Reform and Consumer Protect Act of 2010. This legislation established the Consumer Financial Protection Bureau and gave it unprecedented power to regulate the financial industry. However, many legislators opposed the organization’s methods and conclusions.
President Trump has vowed to change or abolish the agency, so regulation could return to the states. That means that payday lending will remain controversial despite its popularity with borrowers.