Today’s Wall Street Journal had a commentary by Arnold Schwarzenegger and Bill Clinton on payday loans. This political odd couple suggests that the government needs to team up with financial institutions to provide better banking products for “unbanked” and “underbanked” consumers, so they don’t have to pay check cashing fees or take out “high-priced” payday loans.
This issue obviously hits close to home for me. One of the things I’ve learned since I joined ThinkCash is that short term loans and the people that use them are terribly misunderstood by most people — especially the media and politicians.
I’m not denying that the short term loan industry needs to clean up its act. But I think it’s imporant to get the facts straight before pointing fingers:
Fact #1: The single biggest reason that payday loans exist is because of overdraft and bounced check fees charged by banks. Consumers paid $17.5 billion in overdraft fees in 2006 (up 70% over 2005!) — this dwarfs the $8 billion that Arnold and Bill cite as being spent on check cashing, payday loan, and pawn fees.
Bank overdraft fees are essentially short term loans, but because of a loophole in banking law, banks are not required to disclose these fees on an APR basis. For example, my bank, Wells Fargo, charges $39 for each overdraft transaction. So if my account goes negative, I get hit with a $39 fee for every subsequent transaction. So a 25 cent pack of gum can end up costing $40. We know from our own research that it’s not unusual for a customer to ring up hundreds of dollars in overdraft fees every month.
Let’s be clear: Payday loans are almost always a less expensive option than bank overdraft fees. Our customers are smart enough to figure that out, and that’s one of the primary reasons they borrow money from us.
Fact #2: Payday loans provide a much-needed option for consumers. When our customers have a financial emergency — and it doesn’t take much to create an emergency when you’re living paycheck to paycheck — they don’t have many options. Traditional credit options such as credit cards and personal loans aren’t available to these folks. So they can either borrow from friends or family (which usually isn’t an option) or they can get a short term loan (payday loan, pawn, etc.), an expensive option but often the best option available.
But does the availability of payday loans ultimately help or hurt consumers? Well, a recent study from the Federal Reserve Bank of New York found that consumers in states that have banned payday loans (Georgia and North Carolina) bounce more checks and file for bankruptcy at a higher rate than consumers in states where payday loans are available. In other words, people are worse off not having payday loans available as a credit option.
Fact #3: There’s a reason that so-called “unbanked” and “underbanked” consumers don’t rely on banks for their financial needs: Banks have traditionally shunned these customers and even today wouldn’t lend a dime to 95% of the customers we serve.
Check cashers and payday lenders fill a big void in the financial services market and are actually a preferred alternative for many customers. Studies consistently find that customer satisfaction in the payday loan industry is higher than for other financial products including credit cards. There’s nothing keeping traditional banks from serving this market segment with lower priced products… but of course that would mean giving up billions of dollars in overdraft fees.
The bottom line is that payday lenders are an easy target for politicians and the media. They are required by law to disclose their fees on a 2 week loan on an annual percentage rate basis, so it’s easy to point to triple digit interest rates and label them as predatory. But most legitimate players in the industry aim to do the same thing that all businesses aim to do: fill a legitimate customer need and make a profit. We are all for sensible legislation and regulation if it enables us to achieve both of these objectives. But much of the legislation handed down to date has backfired, hurting the end consumer rather than helping them.
Like many important issues, this one is not as cut and dry as it may seem. Highly visible political figures like Bill Clinton and Arnold Schwarzenegger would be well advised understand both sides of the equation before shooting arrows. I have yet to hear one politician propose a viable alternative to payday loans for the millions of consumers that rely on them to make ends meet.