Payday Loan Essay

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For  a  payday  loan,  the  borrower writes  a  postdated  check to a lender,  and  the lender  gives the borrower an amount equal to some fraction  of the face value of the postdated check. Depending  on state  regulations, payday  lenders  will take  somewhere between 15 and 25 percent of the face value of the check as a fee and will provide the borrower the  rest  of the  face value  in cash  on  the  day  the check is written. At the  end of the  usual  2-week period of such loans, the borrower can redeem his or her check with a cash payment  equal to the face value   of  the   original   postdated  check   or   can permit  the lender to present  the check for deposit on the day the check matures. For these reasons, the payday  loan  is also known  as a deferred  presentment  loan.  The  industry  has  grown  dramatically over the past  three  decades and has become a   central   feature   of   the   alternative  financial services industry. With  changing  economic  conditions  and  regulations, the  products have  continued to evolve. The users of these financial products tend  to  be lower-income people;  therefore, there has been a growing debate between industry proponents and consumer  advocates  about  the appropriateness  of  these  financial   products.  In that  context,  the regulatory environment for these products has shifted rapidly  over the past decade.

An early financial  product with similar traits  to the payday  loan  was the “salary  buying”  product of the early 20th  century.  Though  illegal, it operated  in a very similar  manner  as a payday  loan. Modern payday  loans  are financial  products that were developed  as an extension  of the traditional check-cashing  business as alternative financial  service providers  were seeking to sustain  and expand their businesses. Given the apparently high profits of this business, the number  of physical storefronts offering these products grew from about  1,200  in the  mid-1980s  to  more  than  20,000 by the  mid-2000s. With the growing availability  of such loans on the Internet, these numbers  likely understate the total  availability  of  such  products in  the  United States.

Development And Characteristics Of The Payday  Loan

The  payday  loan  is  a  relatively  simple  product. With a relatively minimal credit check, evidence of address,  and  an active checking  account, an individual  can  write  a  postdated check  to  a  payday lender  and  receive a cash payment  the same day; the  individual   simply  needs  to  ensure  that   the amount necessary  to honor  the check is available on  the  date  for  which  the  check  is written. The limits on fees and interest, as well as availability  of such products, vary widely by state. Fees and interest for  payday  loans  are  embedded  in the  difference between  the  amount for  which  the  check is written  and the amount that is actually paid to the borrower on  the  date  the  check  is  written. For example,   to   receive  a  2-week   payday   loan   in Mississippi,  under  statutes   existing  in  2014,  the check writer could write a check on the first day of the  month  but  postdate the  check to the  14th  of that  month.  If the check writer  wished  to receive $100 on the date of the writing of the check, he or she would need to write the check for $122. Consequently, the  writer  of  the  check  would  be paying  $22  in interest  and  fees on the short-term credit,  with   an  implied  annual   percentage   rate (APR) of 572  percent.  While  each  lender  sets its own  limits  within  the  bounds  of regulation, this would  be a common  fee in Mississippi,  and  one finds  that  statutory maximum limits  on  fees and interest rates are often equal to what payday lenders charge.

One  common,   although not  universally  legal, component of payday loans is the “rollover.” At the end of the 2-week term  of the loan,  many  lenders will contact  the borrower to ensure that  there will be sufficient  funds  to honor  the check if it is presented  at  a bank  for  deposit.  If a borrower indicates  that   there  are  insufficient   funds,  then  the lender  will  permit  the  borrower to  roll  over  the loan  through a variety  of mechanisms,  depending on the legal restrictions in a given state. These rollovers may be dubbed  extensions,  renewals, or new loans, but they all have the same effect of continuing the borrowing arrangement and the payment  of an additional fee by the borrower. Given growing concern about the high longer-term cost of repeated rollovers,  rules  and  initiatives  to  reduce  rollovers have  resulted  in what  is known  as an “extended payment  plan,” whereby  individuals  may,  if they are unable to pay the original loan on the date it is due, repay  the loan  in equal  installments over the subsequent four pay periods of the borrower. There have  been  other   efforts  to  extend   the  standard length of payday loans beyond 2 weeks.

Interest  Costs,  Information, And Regulation

Wherever  these products are allowed,  fees in APR terms  in this  industry  tend  to  be quite  high,  frequently  above  200  percent.  There  is some debate over  whether   this  rate  represents   a  competitive cost for such credit, and some groups  have argued that costs of credit in APR terms should not exceed 36 percent  to avoid burdening low-income  households    with    excess   debt.    For    the    standard brick-and-mortar–type  payday   lender,   there   are fixed  costs  of rental  or  facility  maintenance, and there  are  labor   and  transaction  costs  per  loan. Given  these  costs  and  the  relatively  high  rate  of default  for such loans, others  have argued  that  the interest charged must be much higher than standard loan  products and  that  an  APR  of  120  percent would  be somewhat close to break-even  point  for such products, if these products are offered at all.

A  number   of  researchers   have  provided   evidence  that  elimination of  payday  loan  products appears  to detrimentally affect household finances, at least in the short  run, and that  the existence of these products has some positive effect on a household’s ability to handle  some unforeseen  financial shock brought about  by some financial  or natural disaster. These findings are consistent with what industry  advocates  have explained  in their  claims that the number  of alternatives to payday loans are few and that without access to such credit, consumers  would  end up bearing  other costs from utility  reconnection fees, bounced  check  fees, or other  late  payment   penalties.  All these  concerns address  the  short-term financial  position  of low-income families.

While many payday  lenders adhere  to the legal requirements  of  providing   information  on  their loan products to borrowers, there is some evidence to suggest that  irregularities exist in their explanations.  For  longer-term  planning,   when  complete and detailed information on the costs of these products  is  fully  explained   to  borrowers, some choose not to use these products. Notwithstanding what  appears  to be a short-term value to payday loans, some consumer advocates argue that the existence  and  promotion of  these  loans  may  be detrimental to the longer-term financial  health  of low-income  families.

In a political and policy climate with sharply diverging views about  the appropriateness of these products, a great deal of regulatory and legislative action  has occurred.  By 2005,  Georgia  and North Carolina allowed  legislation  that  permitted such payday  loans  to lapse, and  either  through legislation or the courts,  both  Ohio  and Arkansas  eliminated  the traditional payday  loan products. Other states, such as Oregon  and New Hampshire, have enacted  legislation  that   increases  restrictions on the behavior  of and interest  rates charged  by payday lenders. In many other states, regulations have only focused on regularizing the industry  and placing minimal  constraints on the operations of such businesses.  At  the  federal  level, the  Dodd-Frank Wall Street Reform and Consumer Financial Protection Act established  the Consumer Financial Protection Bureau with a view to better  educating consumers,   enforcing   federal   consumer   finance laws, and continuing  research  on consumer  financial products and  markets. At this point,  the Consumer Financial Protection Bureau has had limited ability to engage in any action to affect the payday loan industry.

Bibliography:

  1. Caskey, John. “Fringe Banking and the Rise of Payday Lending.” In Credit Markets  for the Poor, Patrick Bolton and Howard Rosenthal, eds. New York: Russell Sage Foundation, 2005.
  2. Graves, Steve and Chris Peterson. “Usury Law and the Christian Right: Faith Based Political Power and the Geography of the American Payday Loan.” Catholic University Law  Review,  57 (2008).
  3. Stegman, Michael. “Payday ” Journal of Economic Perspectives, v.21/1 (2007).
  4. Stegman, Michael and Robert “Payday  Lending: A Business Model That  Encourages  Chronic  Borrowing.” Economic Development Quarterly, v.17/1 (2003).

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