Half of Americans have almost no savings, according to a May 2016survey by the Federal Reserve. For such people, car trouble or a toothache can trigger financial ruin.
Payday loans are instant, short-term cash advances against someone’s next paycheck. They can help in emergencies, but can also leave borrowers indebted for years. They target people without credit cards — often those with the worst credit — and charge these riskiest borrowers much higher interest rates. Annualized rates are about 390 percent, according to the Consumer Financial Protection Bureau (CFPB), a federal consumer watchdog. (At that rate, a $1,000 loan would cost over $4,000 to repay after one year.) By contrast, credit card interest rate averages tend to hover between 12 and 20 percent.
The market for payday loans grew quickly in the 1990s and 2000s. According to a Federal Reserve estimate, almost 11 million Americans use payday loans each year, spending, on average, over $500 in fees.
States’ attempts to regulate the sector have had limited success. “Confusion reigns as to legal jurisdiction,” note Keith Lowe and Cassandra Ward of Jacksonville State University in a 2016 paper.
In June 2016, the CFPB proposed a new federal rule that would require lenders such as CashAdvance.com, CashNetUSA,OneClickLoan and MyPaydayLoan to determine customers’ ability to pay back high-cost loans while forbidding them from offering new loans to pay off the old ones.
According to the CFPB, more than 80 percent of such loans are rolled over within a month — that is, borrowers borrow more money to pay off the principle, circling deeper into debt. For every five borrowers who offer their cars as collateral, one loses the vehicle, the CFPB says.
Critics argue that the fees are exorbitant and amount to predatory lending. “It’s much like getting into a taxi just to ride across town and finding yourself stuck in a ruinously expensive cross-country journey,” said Richard Cordray, the CFPB’s director, in a June 2016 statement. “Consumers are being set up to fail with loan payments that they are unable to repay.”
The proposed regulation is still under review and could be challenged in the courts. Groups like the Community Financial Services Association of America are lobbying against the rule with their Credit Strengthens Communities campaign. The Center for Responsible Lending is lobbying for more regulation over the industry. Whatever the ethical concerns, proponents say payday loans fill a much-needed gap in services.
What the research says
Researchers are generally split on the impact of payday loans. A 2016 study by Christine Dobridge of the Federal Reserve illustrates the paradox: She finds that payday loans support families during times of extreme misfortune, such as after a natural disaster, “helping households keep food on the table and pay the mortgage.” But in general, “access to payday credit reduces well-being” by encouraging borrowers to over-consume and spend less on such vitals as rent and food.
Writing in the Review of Financial Studies in 2014, Jonathan Zinman of Dartmouth College and Scott Carrell of the University of California at Davis find payday loans negatively impact job performance and retention in the U.S. Air Force. (Under the 2006 Military Lending Act, active-duty service members and their dependents cannot be charged more than 36 percent; the Obama administration has tried to close some outstanding loopholes.)
James Barth of Auburn University and colleagues observe that payday lenders congregate in neighborhoods with higher rates of poverty, lower education and minority populations — sustaining concerns that payday lenders target the vulnerable.
However, Chintal Desai at Virginia Commonwealth University and Gregory Elliehausen of the Federal Reserve find that a Georgia ban on payday loans hurts locals’ ability to pay other debts. They conclude that payday loans “do not appear, on net, to exacerbate consumers’ debt problems” and call for more research before new regulations are imposed.
Mehrsa Baradaran, a law professor at the University of Georgia, wrote in the Washington Post in June 2016 that the loans can be ruinous, but they fill a “void created by banks,” which don’t make small loans to the poor because they are not profitable. She suggests the Post Office take on public banking with federally subsidized interest rates, much the way Washington already subsidizes or guarantees loans for two things primarily geared toward the middle class: houses and college.