Is the Enmity Justified for Payday Lending

Payday Lending

Is the Enmity Justified for Payday Lending

Hello everyone! Thanks for swinging by today. Let’s talk about the enmity held for the payday lending industry. For those of you who do not follow J$ over at Budgets Are Sexy I wonder why the h*** not?! He’s a long time PF blogger and he shares great things on his site. I have been a long-time reader myself and participate frequently in the comments section of his blog posts.

Late last week may have been the only time ever I’ve seen something on his site that I didn’t necessarily agree with and was quick to share my thoughts in the comments. That post was related to payday lending and basically compared it to devil worshipping…ok maybe it wasn’t that bad. But I thought it was fair to take the side of payday lenders, employees, customers and many others who do not agree with his post.

In the comments to that post, you will see that I referenced a Freakonomics podcast that defends the payday lending practice. Today I thought I would highlight some of the main points from that podcast, research conducted by the New York Federal Reserve (Liberty Street Economics) as well as other research and considerations that I’ve learned over the years from knowing folks in the industry.

Disclaimer

I am not a lover of payday loans or the industry, I just want to present the other side of the story. I realize that being a proponent or advocate of the payday industry is not a popular view, and that is not my position. My position is simply defensive of the industry and consumers who benefit from its products don’t lose access to it. As such, I’m trying to be an objective observer and I feel compelled to shed light on the industry in this manner.

What is a Payday Loan?

Payday loans are relatively small loans and are intended to be short term, repaid on payday (hence the name). These loans are typically used for emergencies when you’re strapped for cash and can be a bridge to payday. They are designed to be a quick solution to a short term problem.

Consumers

Research shows that over 90% of the users of payday lending products are satisfied. It’s not cheap, but it offers help. What is important for consumers to know is that if they are going to take out a loan, they should make sure they have the means and ability to repay it quickly which is most often the case.

While this is not an ideal way of borrowing money or to make ends meet, consumers are happy with its products and service and so therefore it seems they have a place in our society and shouldn’t be condemned for it.

How do I know consumers are happy? Besides the research showing over 90% have confirmed their satisfaction, the Consumer Financial Protection Bureau (CFPB) has also confirmed it. While the CFPB is primarily responsible for trying to shut down the payday industry (as we’ll discuss further below), in response to Freedom of Information requests (FOIA), it revealed more than 12,000 positive testimonials, or more than 98% of all comments. Further, while complaints have been minimal (approximately 1.5%), they have also declined over the last five years.

So if the consumers are happy and there seem to be few problems in the industry, why is the CFPB so dead-set on reforming it? Let’s jump into that next…

Obama, the CFPB and the CRL

Obama hates the payday industry and when he created the CFPB it was with the intent to crack down on payday lending. They are not looking to reform or regulate the industry, they are looking to shut it down.

Another big player in the debate on payday lending is the Center for Responsible Lending (CRL). The CRL was founded by a credit union and many funders include banks and other mainstream financial institutions; all of whom would have a substantial amount to gain from the elimination of payday lending.

So while there may be points to be made against payday lending, I think it is important to keep in mind who is really behind the push to “reform” it.

The CFPB is all about enforcement of their agenda and seems to care little about the actual consumer or the businesses it is trying to regulate. Let me provide some examples:

  • Every month the CFPB issues a breakdown of consumer complaints by industry. Every month payday lending has the lowest number of consumer complaints (as confirmed by the FOIA request outlined above). Seems to be a lot of focus on a problem that consumers don’t think is there.
  • The CFPB holds small business panels for review and comment on rule making, yet it appears this is just for cover. Often times their members attend the meetings, take attendance, make introductions, and then walk out and aren’t even present for the review panel.
  • Two years ago, the CFPB issued a Civil Investigative Demand letter against World Acceptance (one of the largest installment lenders in the country) and yet have not released or disclosed what exactly they’re investigating or contorting what the Company did wrong. They have also done this a lot with debt collection companies.
  • The CFPB’s rule making process takes into consideration very limited research. For example, the research completed by the New York Federal Reserve (NYFR) wasn’t factored in by the CFPB.

Questionable practices if I do say so myself.

What Freakonomics did in the podcast was to interview folks who do not have a horse in the race, academia. And primarily research from the New York Federal Reserve (NYFR).

So let’s discuss some of the salient points and see if the CFPB is just trying to throw the baby out with the bathwater.

Primary Issues with Payday Lenders

  1. High Interest:

One of the main gripes is that the annualized interest rate can be very steep, in some instances up to 400%. But again these are intended to be short term. And since the loans are small (the average is $350), the fees need to be reasonable to entice the lender to make the loan (i.e. make a normal profit). For example, for every $100 borrowed, the current fee is around $15. From a consumer standpoint, that isn’t much to pay to get out of a quick bind. And when considering it is a labor intensive process to make a bunch of small dollar amount loans, it needs to be at that level to cover the labor costs and other general business costs and provide a normal profit. This has been confirmed by the NYFR.

And keep in mind, this isn’t a risk free loan. While applicants are required to have a job and a bank account, that’s it. There is no collateral like pawn shops.

Let’s think about payday lending in another fashion. One alternative to a payday loan is to overdraw your bank account. The consumer isn’t dumb, they’ve done the math and realize a payday loan is cheaper than a handful of overdraft fees from the bank which can be up to $35 or more for a single overdraft!

The consumers aren’t unwitting and desperate. They are aware of the costs and do not consider themselves as being preyed upon by the industry. And this isn’t coming from me, this too is coming from research by the NYFR.

By evolving to the 36% cap that the CFPB proposes, that would take the $15 fee to $1.38! Establishing a cap like that would clearly be a death sentence for the industry. Who would make a two week loan for only $1.38 (7.5 cents / day)! It just doesn’t make economic sense.

And the Freakonomics podcast makes an interesting point about how you can view a payday loan as renting money for two weeks, then of course you have to pay it back. Similarly, there is a business for renting cars for short periods of time which are then returned. If you look at the rate you pay for renting a car compared to the value of the car, you are paying a similarly high rate. Yet the CFPB doesn’t make any fuss about this.

Furthermore, because the payday industry is extremely competitive, the market tends to drive fees down.

Conclusion: the fees associated with payday loans aren’t the problem.

  1. Spiraling Fees:

Spiraling fees implies that fees get greater over time if a payday loan is rolled over. That isn’t industry practice, however. The fees associated with a  rollover are the same as the initial fees.

Conclusion: Not applicable and irrelevant.

  1. Trapped in a Cycle of Debt

Yes, another huge gripe and certainly not a positive attribute. They NYFR acknowledges this appears to be the problem. Ideally you could target individuals who are more prone to incessantly rolling over the payday loans, but the counter to that is the increased costs put on the system to gather data from the consumers and screen them more thoroughly would not be economical. And this isn’t me talking, this is the opinion of the NYFR.

However, there is limited research on the topic and it appears to be mixed. In 2011, an economic research paper was published documenting a study where a randomized control trial was completed where one group of borrowers were given a traditional high interest rate loan and another group of borrowers were given a zero interest rate loan. The conclusion was that both groups were equally likely to roll-over their loans again.

Although little research is available on rollovers, the conclusion the NYFR makes is that they are the ultimate problem, but that further research should be conducted. Will the CFPB listen, no. Instead, they intend to throw the baby out with the bathwater.

The basic premise of the debate is on one side Obama and regulators wanting to “reform” the industry and payday advocates are saying that it will ultimately kill off the industry and leave borrowers in the lurch. So what’s the answer, is payday lending a benefit to society or not…?

Is Payday Lending a Benefit to Society?

Research is mixed here as well. Oregon, for example, recently capped its rates from 400% to 150%. As an economist might predict, the industry was exited in mass. Washington, a neighbor state with lots of similarities to Oregon, also considered similar legislation but ultimately didn’t. This presented a nice natural experiment for researchers to determine the benefit.

The results? The research concluded payday consumers were worse off in Oregon as a result of the legislation.

A different study was based on use of payday lending by military personnel. The study looked at the use of payday lending outside of military bases and how it impacts our military operational readiness. The study looked at personnel data including job performance and military readiness and could look at various state laws on payday access.

The results? Greater payday access negatively impacted active personnel operational readiness.

Another example may be forthcoming with South Dakota which has a ballot initiative coming up this November to vote on whether to cap rates at 36%. The industry view is that it will likely pass and the industry will fold soon thereafter. We’ll have to wait to see the outcome here…

Final Point

As I commented on J$’s original post, the payday lending industry is an easy target. But is it misguided? Or is it a symptom of a larger problem? Remember, that to get a payday loan you need to have a job and a bank account. So what does it say about our economy and constituents who have a job, but cannot afford spontaneous and unexpected expenses. Is the bigger problem a lack of good paying jobs, wage deflation, or financial literacy (which is my cash cow)? What should we do about these issues? Well, the next Freakonomics podcast was on the pros and cons of a guaranteed national income…Aren’t their podcasts always so thought-provoking!?

Conclusion

Allow me to reiterate that I am not an advocate for the payday loan industry and neither am I involved in the industry. But I am an advocate of complete disclosure and I hope this article helps show there are two sides to the story. For those of you who are interested to learn more in formulating your own view of the industry, I’d recommend the linked resources throughout the article including the Freakonomics podcast and the research reports found on NYFR which both offer fair, unbiased and balanced viewpoints (previously linked above).

Thanks for taking a look!

The Green Swan

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ADI

Oh wow, this is a really interesting post. My primary concern with the industry is the repeat user, who is constantly paying $15 to advance $100. Its just a huge chunk of change to pay and adds up quickly over time. I do agree that short term lending can provide a service in the one-off case.

From my understanding a lot of the concern surrounds the fact that people aren’t necessarily made aware of the fact that interest rates can be as high as 400%. I wonder if that satisfaction figure takes that into account? I’m not sure anyone would ever be satisfied paying 400% interest! I think the financial literacy point you made in your conclusion is spot on.

JW

I agree, ADI. Which is why my opinion is skewed toward the need to for further research and perhaps reform of the industry rather than killing it completely as the CFPB would like to do.

The public concern is around the high interest rate, but I would revert back to the car rental example and the fact that they are paying $15 for renting $100 for two weeks. That doesn’t seem like an outrageous price and payday lenders require this to be profitable…it isn’t cheap to originate enough small dollar and short term loans.

And yes, let’s all emphasize continued financial literacy for America!

Thanks for the comment, ADI.

J. Money

Well, you’ve accomplished an interesting take on it, good sir! I can’t say I’ve ever heard anything positive about payday loans before in my 8 years blogging about money, but I must say my brain is working hard trying to comprehend it all 🙂 I will agree that better financial management solves everything too (payday related or not) but I also know $hit happens and we’re all dealing with different circumstances. So if those satisfaction rates really are high, well, at least their money is paying for something! Either way, appreciate the new lens on this and glad you like all of my posts except for one 😉

JW

The reality is, J$, that the entire population of America is not as fortunate as you or I to not require the services of a payday lender. But just because we don’t use them doesn’t mean that aren’t a helpful resource for many folks. For the most part, payday lenders are respectable outfits, the employees are good people, and the customers appreciate the services. Doesn’t sound like we have a problem here. Going back to the post, perhaps we are just looking for the problem in the wrong spot. Perhaps it has to do with the poor economic conditions for low income earners. And perhaps killing the payday lending industry won’t solve the problem, but rather make it worse by leaving its customers in the lurch similar to the experience in Oregon.

Thanks for sharing your thoughts, J$.

Jon @ Be Net Worthy

GS, I love that you are taking the unconventional view. I did not see the conversation over at J$’s site, but do not have a favorable view of the industry. I think the situation is similar to the large sodas that were outlawed in NYC. Why can’t people buy a large soda if they want to? Do I need the government telling me how large a soda I can buy?

No, you don’t, but drinking that much soda is not a good idea, especially on a continuous basis. Since there is no way to monitor who is buying continuously vs. occasionally, we have to outlaw them for everyone.

As you stated, the issue is one of education and self-discipline. People are not saving up enough money so they can get out of an unexpected financial bind. Unfortunately, it’s human nature to spend every last penny and then if you need to, hit the payday lender if you get in a bind.

I can see the argument on both sides of the issue. For me, the bottom line is that I know I would not be comfortable being in the payday loan industry or having to explain to my kids what I do for a living if I was. So, maybe that says enough about my feelings right there.

Thanks for sharing the other side of the discussion!

JW

Hi Jon. I’d have to disagree with you regarding the sodas. My view on that is that soda needs to be regulated not simply because of the fact there are abusers of consumption, but because of the reliance of those users on tax payer funded healthcare services. Keep in mind that 30-40% of all healthcare is funded by the government in Medicare, Medicaid and now subsidies on exchanges. This makes the abusive consumers problem the taxpayers problem. That situation doesn’t correlate to payday lending. You’ve never heard of a government bailout of payday lenders or borrowers.

And I agree with your financial education comment and also add the fact that most payday borrowers aren’t high income earners, so I think the necessity to borrow is in part that lack of sufficient income but also on the expense side and failure to budget / plan accordingly. I think that is the harsh truth.

I’m glad you can see both sides, but don’t fully understand why you would be ashamed telling your kids being a payday lender was your job. It isn’t a morally corrupt industry and the employees / small business in owners, in the most part, are good folks providing a good and necessary service with high satisfaction rates. I just think the American perception has always been unnecessarily negative unless you actually have been part of the industry (employee or borrower).

Thanks for keeping your mind open to both sides though. I hope others do as well. Thanks Jon.

Matt @ Optimize Your Life

If the rationale for regulating soda is that people that over-consume end up being subsidized by tax payer funded healthcare, then couldn’t you draw a parallel to over-consumers of payday loans (those in the debt cycle bullet point) ending up being subsidized by tax payer funded safety net programs?

It sounds like from your research there is a place for payday lending in the market and that it should not be killed off. But there are also people that get trapped in debt cycles. (I would also challenge the statement that “The consumers aren’t unwitting and desperate.” While many, or even most, may not be, a blanket statement that people who have resorted to renting money for a short term emergency are not desperate for that money in some way seems over-broad.)

Given that, do you think there are any policy changes that could help mitigate the negatives without destroying the positives? Acknowledging that the better solution would be to make payday lenders unnecessary through a bolstered economy with more jobs and higher wages, could there be any specific efforts targeted more narrowly at payday lenders or their consumers that could help in the short term?

I don’t actually have a position on this one way or the other, but it is a really interesting discussion. Thanks for presenting the under-covered side of the debate.

JW

Hi Matt. I can see your logic with regard to your comment on safety net programs, however, I’m not sure the relationship is the same as the one for soda and increased healthcare. I’m not so sure those who utilize payday lending wouldn’t are aren’t already utilizing the safety net programs to begin with.

I think it is a challenge to find appropriate regulation for the payday lending industry that would reform it without killing it. Many states have taken up this challenge by regulating the number of roll-overs, allowing only “installment loans” rather than “payday loans”, and adding “cool-off” periods in between roll-overs. I think my conclusion, along with the NY Fed’s conclusion, is that more research needs to be done to find the right solution. But I am a fan of different states trying reform individually rather than the CFPB’s broad-brush approach to wiping out the industry completely.

Thanks for keeping an open-mind, Matt. And like others who have commented, I think we all agree that improved financial literacy in the country would help in this matter.

Apathy Ends

I went and listened to the podcast after reading your comment on BudgetsAreSexy last week. Definetely an eye opener and moved my opinion drastically from evil empire.

The car example was pretty interesting, if you look at the money as a product or service instead of a loan your perspective changes

JW

Thanks for giving it a listen and keeping an open mind. Just like many things in life, it’s not as bad as it seems one you’re willing to educate yourself on the topic and keep an open mind to other perspectives.

Thanks for sharing your thoughts!

Dividends Down Under

There’s always a reason why people take out these loans. When we think of supposed bad habits like cigarettes, gambling, alcohol – people would probably be better without these. But they’re legal.

I can’t remember whether it was Australia or the UK I was reading about – but I saw annual rates of like 1,893% – that’s clearly unsustainable for the person taking it.

I think it’s just something that people shouldn’t and don’t need to do. It’s financially taking drugs kind of, I can totally understand why people think that. Depending how much they see their customers as prey, I think they’re further along the devilish line. There’s a market for them, and it’s being filled. I’d prefer that they weren’t needed, but there are worse ills out there.

Tristan

JW

I’d agree with that viewpoint, Tristan and think you said it well. I too would prefer payday lending wasn’t a necessary service.

Thanks for stopping by!

Emily @ JohnJaneDoe

Interesting, and I love that you’re not afraid to go against the common thought process.

I’m still not sold on pay day loans, and am happy enough that NC does it’s best to keep them away. But, I have access to other forms of credit. I have an emergency fund. I don’t need their services, and I’m not their target market.

This past year I worked with customers who were very willing to pay high proportional fees for a little credit. It made me uncomfortable, but they wanted to do it, were eager to do it, in part because a lot of them were unbanked and paying fees for all kinds of services that were free to those of us with banks, credit cards, etc. It’s a very different mindset, and I guess the satisfaction with payday loans is part of it.

FinanciaLibre

Great post on a highly controversial topic!

So I guess this is one place the analytical viewpoints of economist-types seem unsavory to everybody else. Which is to say, so long as the relevant cost information is made readily available and understandable to prospective borrowers, it’s hard to really argue PDL is a terrible thing. People who are in need of cash and who would otherwise face greater costs in late fees, penalties, etc. can make reasoned choices on their own to do what they deem best. Even Thalerian “paternalistic libertarianism” would have trouble arguing otherwise.

“Fairness” seems to be in the eye of the beholder. And it seems condescending to suggest someone can’t/shouldn’t do something that might reasonably be in their best interest just because others (who are not similarly situated) deem it unfair. Is it fair that people incinerate ungodly amounts of cash on street-legal race cars for their daily commutes? Those cars are obviously a bad financial choice. Should we cap the cost of cars at $10k? Should we restrict imports of Ferraris? Laissez-nous-faire seems fair to me.

JW

Thanks FinanciaLibre! And to the point, yes fees ate disclosed on the front end as you would expect. Thanks for sharing your viewpoint, very well articulate and hard to argue against!

Linda @ Brooklyn Bread

REALLY interesting and impressively reported story. I can totally see what youre saying and you definitely make an important point. If a person is having a temporary emergency and needs a quick fix and can get a payday loan and pay it back when they need to, who am I to say they should not have this option. I just think that it is inherently lousy for a business to exist solely to profit off of the financial hardship of those who can least afford it. This is a business model that, in order to be viable, requires putting at least some precarious people in even worse financial shape. That’s baked in to the math. And no question that there are some very disturbing anecdotes out there. It just sucks that this is the only option for so many people, and that there is no not-for-profit or government entity that can provide this safety net. Like healthcare, I just don’t think a profit motive is particularly helpful here if you want to live in a society that doesn’t eat its own.

JW

Thanks Linda, I appreciate you sharing your viewpoint.

I will make a couple quick comments and counter-points. I hear your empathy for the financial situation folks are in that utilize this service, but not even not-for-profits can provide this service free. There is costs involved and there has to be a business incentive to provide it. Not-for-profits couldn’t really provide it much / if any cheaper. Some payday lenders are publicly traded entities and you can see for yourself that they aren’t making out-sized profits for the business risk they are taking.

And payday lending isn’t the only business model that exists to benefit on the hardships of others. Think about some of the common reasons people use payday stores such as a car repair, illness, even speeding tickets. The reasons are endless really, but should a car repair shop, hospital, or police officer not charge an individual if it means having to get a payday loan.

I agree with you that this industry today does benefit from putting some precarious people in worse financial shape and I would follow the NY Fed recommendation of further research and consideration on how to handle folks who are more prone to rollovers. I wouldn’t view this as an industry trying to eat its own, but that’s just me.

Thanks again for stopping by and sharing!

Gary @ Super Saving Tips

Really interesting information, JW. I’m still not sold on payday loans as I believe the consumers are generally happy only because they don’t fully understand their alternatives (both short and long term). Rather than trying to cap interest rates, maybe we should be devoting more resources to promoting financial literacy.

JW

Perhaps that is true, but I think they are also happy because they are getting fair value for a service and are also being taken care of from a customer service perspective. If not, I think there would be plenty more unsatisfied reports documented through the CFPB. But I fully agree that an ultimate solution would be dedicating resources to financial literacy. I think the government would be well served by investing in public service announcements, campaigns, and free educational classes.

Thanks for stopping by and sharing, Gary.

FullTimeFinance

I can see both sides of the argument. On the one hand these folks are operating as a lender of last resort. There needs to be one of them for folks who get themselves in that situation. There is also a huge amount of risk associated with being that lender. They need to be compensated for that.
On the flip side most cultures and religions started with the concept that high interest rates or Usuary was bad because it was taking advantage of people. Studies have shown that individuals under high stress are less likely to think their actions through. Ensuring they understand the terms is very important.

JW

You may be onto something there! I can see how history and religion may result in folks pre-disposed to not liking this industry. Everyone hears the high annualized interest rates and think it is usury, even when in fact it isn’t. I like your balanced viewpoint, thanks so much for sharing!

Frugal familia

I never realized that this was such a ‘controversial’ topic. After all this is the USA where we proudly tout free markets and capitalism isn’t it? If there wasn’t a need for these services they simply wouldn’t exist. These loans are considered extremely risky and lenders should be compensated as such.

Mustard Seed Money

While I admittedly don’t know very much about the payday lending industry, I found this article extremely interesting.

I’m a big believer in the free market and if these practices were really unfair to the consumer then they wouldn’t use it and/or other entities would join the market forcing the price point lower.

I find it amazing when politicians without economic backgrounds force ideas that sound great in theory but don’t add up in the real world aren’t held accountable for their market destroying actions.

JW

Thanks MSM. I totally agree regarding the free market, we see this work everywhere in our daily lives.

It is pretty amazing the damage politicians can inflict on the economy. Especially when the Federal Government can leave many decisions to the State as independent laboratories to help find the best solution overall.

Thanks for the comment, Mustard Seed.

Laurie @thefrugalfarmer

I hate the payday lending industry just as much as the next person, but I do value free enterprise, and people need to learn to make smarter choices with their spending if they don’t want to be “taken advantage of” by payday loan companies. I guess what I’m trying to say is that I’m also a proponent of the self-education that can help people stop using payday loans, but if they want to continue to waste their money that’s their choice too. Great take on the subject, GS!

earlyretirementnow

Thanks for pointing this out. I’m no fan of the PDL industry, I will never borrow money from them (we have our HELOC for short-term liquidity needs), but I can understand that they serve a purpose. Life is rich with examples of insanely high implicit interest rates. Example: either pay a bill in full today or face the bill plus a huge late fee tomorrow. Or the utilities are shut off, or the car repossessed, etc.
In some instances, this implicit interest is even much higher than the 400% IRR on the PDL, hence there can be a societal benefit of the PDLs.
The ultimate irony is that some of the financial emergencies that necessitate taking out payday loans are created by the same government that complains about the PDL industry.

Adam @Crispy Cabbage

Great article! Unbiased and full of great info. I took out a payday loan back in the early 2000s and didn’t feel taken advantage of at all. I knew exactly what I was getting into and the fees were much more clear than a lot of the fees in the banking industry. The loan was for Christmas gifts, since i was spending the rest of my money on traveling back home for the holidays. I didn’t feel particularly proud of taking the loan and would plan better today, but it didn’t put me into any sort of debt spiral. I almost think that putting the gifts on a credit card would have been worse, because I wouldn’t have felt the pressure to pay it off right away. That wasn’t an option though. Back then, those were already maxed out 😉

JW

Hi Adam, thanks for sharing your inside view and personal experience. From my limited research, it seems your experience is common or the norm. I appreciate you stopping by and sharing!

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