Benjamin John Coleman wants to ban payday
loans from Rhode Island because he knows what it feels like to be
desperate enough to take one out.
Even though he never had a payday loan.
Coleman, who has been in
recovery for four years, said he turned to short-term credit six years
ago to simply get money for drugs. "I didn't care what the interest rate
was," he says.
What Coleman is hoping to do
in Rhode Island has already happened in other states. Arizona's
effective ban on payday loans went into effect in July 2010, for
example. Santa Clara County, Calif. limited the number of payday loan
stores in May.
At the center of the debate is
what critics call the payday loan debt cycle. It works like this:
People don't have enough money to pay their bills so they take out a
payday loan. When they get their next paycheck, they pay back the entire
loan plus fees that are equivalent to triple digit annual percentage
rates. This, unfortunately, leaves them without enough money to pay
their bills, so they take out another payday loan. Wash. Rinse. Repeat.
Richard W. Evans, an assistant
professor of economics at BYU, who says he did some consulting work for
payday lenders back in 2009 and 2010, doesn't think so.
"You do see people abuse these
loans," Evans says. "But that is not specific to the payday lending
industry. You can find people who 'can't handle their liquor' in
mortgage markets, in credit card markets — in any debt market you have people who over borrow."
Here is your typical person
who takes out a payday loan according to the Consumer Federation of
America's national expert on payday lending, Jean Ann Fox: They have a
low to moderate income. They have to have a bank account to be eligible
for the loan. They have to have a source of income. "Consumers who use
payday loans are not the most destitute in society," Fox says. "They are
banked and they have a source of income."
Nathalie Martin, a professor
at University of New Mexico's School of Law, and an expert on consumer
law, bankruptcy and predatory lending products, says her studies show
most people are taking out payday loans not for emergencies, but for
regular monthly obligations. "It just creates a situation where next
month or two weeks from now they have another bill to pay," she says. "I think people are far better off without this type of credit."
A study by the Center for Responsible Lending
showed that 76 percent of payday loans were taken within two weeks of
another payday loan — meaning that three-fourths of the loans were from
people in the payday loan debt cycle.
For Evans, banning payday
loans would be like banning credit cards because some people do not use
them responsibly. The question is not one of banning, but of personal
responsibility and freedom. The problem is not unique to payday loans.
Evans says payday loans are
part of a continuum of different debt products — ranging from 30-year
mortgages to installment loans for furniture. There are credit cards,
revolving credit, payday loans, title loans, payday loans and so forth.
And payday loans are very
transparent, Evans says. "It's just a simple transaction," he says. "You
go in. You borrow $300. And then you go back and you pay back $300 plus
$45 in two weeks. That's the basic transaction."
But it is the easiness and
simplicity that bothers Fox with CFA, "The easy solution of walking into
a payday loan store and writing a check when you don't have money in
the bank and promising to pay it all back out of your next paycheck at
triple-digit interest rates, to keep that check from bouncing and
triggering overdraft fees, — that is not a solution," she says. "It adds
to your problems."
NOT AVAILABLE EVERYWHERE
Payday lending isn't
everywhere. Some states allow the loans with few regulations. Others put
on various restrictions that are aimed to break the debt cycle — such
as limiting the number of consecutive loans. Others have banned them
outright or lowered the interest rate so they are not profitable to
lenders.
"Payday lending, the way the
industry wants to do it, is only legal in 37 states," Fox says. "About a
third of the population of the United States live in a state that does
not authorize single-payment, triple-digit-interest-rate loans."
North Carolina's payday laws
were allowed to expire, ending the practice — and making an opportunity
to see how ending payday lending affected people. But when a state ends
payday loans, such as North Carolina, Evans says the results are mixed.
"There is evidence on both sides," he says. "Some studies say that when
payday lenders were banned, delinquencies and bankruptcies went up.
Others showed that the (area) with payday lenders had more
delinquencies. So it is an open question."
Martin agrees that the studies
are not clear. "Some show people are better without this," she says.
"Some show people are better with this. So they are really
inconclusive."
The Community Financial Services Association of America,
a trade association for payday lenders, says on its website that
studies don't show a payday cycle because the number of times a customer
can take out a loan is limited in most states. CFSA member lenders also
offer extended payment plans at no extra cost if the borrower can't pay
back the loan in time. "The vast majority of Americans, undeniably, use
payday advances responsibly and, as intended, for short-term use," the
CFSA website says. "State regulator reports and public company filings
confirms that more than 90 percent of payday advances are repaid when
due and more than 95 percent are ultimately collected."
But whether there is a cycle or not, how are those fees eventually collected?
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BREAKING FREE
Fox says up to 50 percent of the people taking out payday loans eventually default. "They just can't keep it up," she says.
If they default, they rack up bounced check fees. They may lose their bank account. Lenders initiate debt collection.
In other cases, people use their tax refund to pay it off.
People may go to their family for help.
People ask for help from
churches. They've gone to credit counseling. They go to food banks and
use the money they save to pay off the loan.
They may go for a larger loan, which puts them in a different type of trouble, Fox says.
Andrew Schrage, co-owner of Money Crashers Personal Finance (
MoneyCrashers.com), says in extreme cases, people can always file for bankruptcy. "But keep in mind that this ruins your
credit score, which takes years to rebuild," he says.
ALTERNATIVES
Evans list of alternatives to
taking out payday loans isn't pretty. "One product people move into is
to overdraw their bank account and then pay those fees," Evans says.
Bankruptcy is another "option."
People can borrow on a credit card.
They can do installment loans or collateralized loans (like title or pawn loans).
People can borrow against their home equity.
Each of these loans has a different maturity and level of collateralization, Evans says.
Fox says the first line of
defense against using payday loans is an emergency savings account.
"People say they can't afford to save money," she says, "but you can't
afford to pay $75 to borrow $500 every payday either."
Fox says for a family making
$25,000 a year, just $500 in an emergency savings account will make it
eight times less likely they would take out a payday loan, she says.
The best time to set aside an
emergency fund is during tax season when people get their earned income
tax credit and child tax credit. Then, if there is an emergency or an
interruption in income, people can borrow from themselves and pay
themselves back when they can. This puts less stress on a family than
borrowing that money and having to pay it all back on the next paycheck
with fees.
Lower cost small dollar loans are sometimes available at credit unions.
"(When payday loans are not
available) people do what you do when you run short of money," Fox says.
"They juggle their finances, ask their family for help, ask for more
time to pay their bills, ask for an advance on their next paycheck — the
things people have always done when they have trouble making ends
meet."
Schrage thinks a personal loan
from family or friends is the best resource for help in lieu of payday
loans. "If you can secure a loan from a friend or family member, do
yourself a favor and put the agreed upon terms in writing to protect
both parties," he says. "Also, whatever terms are agreed upon, stick to
them as best you can. This way, your loan won't have any negative
effects on your personal relationships."
CREDIT CARDS
And there are always credit cards.
"It is certainly much less
expensive to take out a cash advance on your credit card — it is still
pricey, but it is much less expensive than getting a payday loan that
has to be paid back at one time," Fox says.
But, surprisingly, a study in the May 2009 American Economic Review on
"Payday Loans and Credit Cards"
found that "most borrowers from one payday lender who also have a
credit card from a major credit card issuer have substantial credit card
liquidity on the days they take out their payday loans."
In other words, they could have borrowed that money on their credit cards at a much lower interest rate.
Why don't they? Evans thinks a
payday loan forces people to pay back the money sooner. "They are
committing themselves to pay it off," he says.
FINANCIAL LITERACY
Martin thinks the problem is
financial literacy and a general culture of immediacy. "The real problem
is people are not aware of how much money is coming in and how much is
going out," Martin says.
Schrage agrees.
"Your best bet is to simply take control of your finances so that a payday loan is never a necessity," he says. "Create
a personal budget
for yourself, and commit to spending less than you make. Cut costs
wherever you can, and try to generate more income, either on the side,
or by working more hours at your day job."
Fox still sees payday loans as
a trap — saying there is usually not enough money to pay back a payday
loan in two weeks — even if the loan is free. "You don't solve a debt
problem with more debt," Fox says.
Evans, however, says payday
loans are no worse than any other type of debt if used responsibly. "In
any debt product, there is a risk of getting into a debt spiral," he
says. "In the United States, you and I have the liberty to take on more
debt than we can handle. The risks of payday loans are not any greater,
and are probably less than other lending products."
