Campaign Against Payday Loans Will Hurt Consumers
The Lima News
April 24, 2008
by: John Berlau
A few weeks after the presidential primaries, another national campaign has headed to the Buckeye state. National self-styled consumer advocates have been lobbying the Ohio Legislature to ban or severely restrict payday loans.
But if this campaign prevails, Ohio consumers will be the losers through reduced competition and higher borrowing costs. And the only likely winners would be big banks and credit unions raking in fees from borrowers.
Payday loans are typically two-week loans ranging from $100 to $500 to tide a consumer over until the next paycheck. Often associated with the very poor, studies have shown they cross demographic lines. They are used when there is a sudden need for cash due to unexpected circumstances such as a car breaking down or unplanned emergency travel. They are often used so a borrower in these circumstances can get money to pay other bills on time.
Anti-payday politicians, such as former Democratic presidential candidate John Edwards, say these loans are “predatory” and take advantage of desperate borrowers. But the alternatives — such as bank “overdraft” fees for bounced checks and late payment charges on utility bills — can be even more costly. A November staff report of the Federal Reserve Bank of New York recently concluded “‘payday credit,’ as expensive as it is, is still cheaper than the close substitute (of) bounced check ‘protection.’ ”
Evidence is already mounting from other states that caps on payday loans reduce choices for consumers and leave them financially worse off than before. And, ironically, the main beneficiaries of laws pounding on payday lenders have been big banks and credit unions making millions from the overdraft fees that frequently serve the same purpose as a small loan for unexpected circumstances.
Proponents of the price controls throw out numbers designed to make interest on payday loans look astronomical. They correctly say the loans have an annual percentage rate of more than 300 percent, but fail to note that very few borrowers actually pay this entire amount. This figure is derived from a typical $15 interest payment for a two-week $100 loan multiplied by 26, the number of two-week periods in a year. While studies have shown many payday borrowers do borrow more than once during a year, rarely, if ever, would someone pay 300 percent on a single loan.
In fact, many of the alternatives to payday lending would have a much higher effective interest rate than payday loans. A report by the Annie E. Casey Foundation, a left-of-center policy group, found banks’ “fee-based bounce protection programs are functionally equivalent to payday loans when used by customers as a form of credit.” The report concluded that, “when used on a recurring basis for small amounts, the annualized percentage rate for fee-based bounce protection far exceeds the APRs associated with payday loans.”
A study by the National Association of Community Credit Unions estimated a $48 fee on a $100 bounced check has an annual percentage rate around 1,200 percent.
Yet by setting the interest rate on payday loans so low as to effectively ban them, bills put forth in the Legislature almost ensure that more costly alternatives like bounced check “protection” may be consumers’ only recourse when they need cash quickly. The bills set the maximum annual percentage rate at 36 percent. Again, this number sounds high, but the key word is “annual.” Divided by 26 into a payday loan’s two-week duration, this means payday lenders could only charge $1.38 on a loan of $100.
“Payday advance lenders could not even meet employee payroll at that rate, let alone cover other fixed business expenses and make a profit,” according to the Community Financial Services Association, a trade group.
And when the government forces payday lenders out of a state, the lack of competition hurts the very consumers these laws claim to help. The New York Fed report found that, when Georgia enacted laws similar to those proposed in Ohio, households bounced more checks and filed for bankruptcy at a higher rate. The authors concluded this “increase in bounced checks represents a potentially huge transfer from depositors to banks and credit unions.”
Perhaps not coincidentally, the Center for Responsible Lending, which is pushing for the payday ban in Ohio, is affiliated with the Self-Help Credit Union. This national financial institution could benefit from the increased bounced check fees that may result if Ohio bans payday loans.
Payday loans, like all innovations, arose as a cheaper way to meet a need in the market. Now, with their growth, some banks and credit unions are offering small loans as well that potentially could be cheaper than payday loans. This is all to the good. But these institutions may cease these offerings were the competition from payday lenders effectively banned.
John Berlau is director of the Center for Entrepreneurship at the Competitive Enterprise Institute.
