Payday of Reckoning

New laws aimed at kneecapping payday lenders will end up hurting the poor.

The payday loan store is white, almost antiseptic, except for the large colorful posters in English and Spanish announcing fast loans, check cashing services, money orders, and prepaid debit cards. The location is a small storefront in suburban Virginia, a few blocks from the last stop on the Washington, D.C., Metro yellow line. The scene bears little resemblance to the gritty loan-shark image evoked by the many powerful critics of “predatory lending.” The only hint of seediness is the large sheet of tinted, presumably bulletproof glass separating the weary clerk from loan seekers.

Why do people here and elsewhere seek short-term, high-interest loans, using a chunk of their next paycheck as collateral? Well, what would you do if you needed $200 RIGHT NOW?

You could put it on your credit card. It’s the American way! Unless, like so many Americans, you’ve already maxed out your cards. The average U.S. consumer carries $6,226 in plastic debt, according to the credit reporting agency TransUnion. With a potentially long financial market contraction ahead, card companies have been aggressively reducing limits and discontinuing new offers. Although the Credit Card Act of 2009 makes it harder for companies to change their terms after the fact, the availability of credit is likely to shrink further. Maybe you need that $200 to make the minimum payments on those maxed-out cards.

You could write a personal check and hope to scrounge some money for your bank account in time to cover the transaction. Such faith has a low rate of return, and dashed hopes can be awfully expensive. A bounced check from a basic Bank of America checking account, for example, costs $35, plus any fees the stiffed merchant tacks on. Many banks offer overdraft protection—they’ll extract the money from you later—but charge between $10 and $35 for the favor. Repeated bounces and overdrafts have more serious consequences. American banks unilaterally closed 6.4 million checking accounts in the pre-recession year of 2005 alone. 

You could borrow money from friends or relatives. Obtaining cash from intimates may get you the best interest rate on the market, but costs are extracted through other means. Family reunions can easily become awkward investors’ meetings, and as fans of Judge Judy can tell you, even a small loan can be a remarkably efficient way to destroy a friendship.

You could pay a bill late. A high-risk strategy. Utility and phone providers can be quick to cut off service and charge a disconnect and/or reconnect fee. You could be looking at an extra $40 to $70 penalty every time, not to mention costs incurred in lost productivity.

Or you could get a payday loan. Like I did.

Predatory Lending?

Payday lenders are the redheaded stepchildren of the consumer financial market. According to critics ranging from anti-poverty activists to the president of the United States, the industry exploits the poor by offering loans with bad terms to people who don’t know better. During his campaign, Barack Obama promised to “work to empower more Americans in the fight against predatory lending” by capping “outlandish interest rates.”

The coalition against payday lending is broad and deep, with opponents surfacing in unexpected places. In 2006 the Department of Defense issued a report slamming payday lending to soldiers, sailors, and Marines, characterizing them as “young and inexperienced borrowers” with limited ability to repay. Congress took up the cause, with Sen. Robert Menendez (D-N.J.) claiming that clusters of payday lending shops around military bases “negatively impact military readiness.” The following year saw a new federal law capping the annual rate on loans to active-duty military personnel and their families at 36 percent. In addition to the 12 states that have banned payday lending outright, Virginia has prohibited payday loans to members of the armed forces and their families.

With a powerful ally in the White House, payday loan opponents started to focus their efforts on the federal level. In June 2009, as part of its response to the financial crisis, the Treasury Department proposed consolidating various financial regulatory bodies into a single new bureaucracy called the Consumer Financial Protection Agency. Payday lenders, now largely unregulated on the federal level, are likely to fall under the new agency’s domain, which would make it easy for Obama to reach his goal of extending the military rate cap to “all Americans.”

As new post-crisis financial regulations began taking shape, the president and others started lumping payday loans with credit-default swaps, no-documentation mortgages, high-interest credit cards, and other financial products designed to make it easy—perhaps too easy—for the poor to take on debt.

Terms for payday loans can seem onerous. Interest rates on the short-term deals, measured on an annualized basis, often reach 400 percent. Borrowers who are living paycheck to paycheck can find themselves coming up short after the initial loan, beginning a cycle of indebtedness with ever-higher interest payments. But several recent studies suggest that well-intentioned restrictions on payday lenders wind up harming the very people such laws are intended to help, reducing their access to emergency cash and prompting them to use costlier, more dangerous, and more credit-damaging options.

Repeat Customers

Approaching the Virginia payday loan store in the freezing winter wind, I’m greeted by festive green banners offering check cashing for tax rebates. Inside, the line is composed entirely of females, mostly black women in early middle age. Judging by their clothes, several are on lunch breaks from white-collar jobs. I’ve only just arrived, but my fellow loan seekers are getting restless. The line is 10 people deep and moving slowly.

Editor's Note: We invite comments and request that they be civil and on-topic. We do not moderate or assume any responsibility for comments, which are owned by the readers who post them. Comments do not represent the views of or Reason Foundation. We reserve the right to delete any comment for any reason at any time. Report abuses.

  • Bertha Lewis||

    Instead of demonizing payday lenders, why not go after the major banks that own them?

  • Bertha Lewis||

    (I'm not directing the above question to Katherine Mangu-Ward, but rather the people who want to take out payday lenders)

  • ||

    Apparently the U.S. needs something like the Grameen Bank to bypass these village money lenders by making payday loans with below-market interest rates.

  • ||

    The Grameen Bank does not lend with below-market interest rates. It has NEVER done that - they simply make debtors snitch on each other to make sure everybody pays.

  • New World Dan||

    How 'bout we just teach the poor to, you know, budget and not pay 20% interest plus fees. If we could do that, we wouldn't have so many poor people.

  • I, Kahn O\'Clast||

    People who use payday lenders are too committed to their xbox. wii, flatscreen, bling, whathaveyou to go the traditional rout for people who need quick cash: The pawn shop.

    I am in favor of a free market, but payday lending is just another reason it is more expensive to be poor than middle class: transaction costs eat up huge amounts of wealth.

  • Barney Rubble||

    Choice is good, except when our overlords deems we are making bad ones.

  • John Tagliaferro||

    (I'm not directing the above question to Katherine Mangu-Ward, but rather the people who want to take out payday lenders)

    As long as she splits the check I will take her anyplace.

  • AssWipe||

    "I am in favor of a free market, but payday lending is just another reason it is more expensive to be poor than middle class: transaction costs eat up huge amounts of wealth."

    Not as much as lottery tickets. There is a reason the poor don't have money and it isn't due to capitalism or free markets.

  • AssWipe||

    And a t $5.00 a pack, why do the poor smoke? Most of the "homeless" do too.

  • AssWipe||

    You can fill your belly on $5.00/day.

  • Xeones||

    And a t $5.00 a pack, why do the poor smoke?

    'Cause the evil tobacco companies force them to by filling their products with all that smooth, delicious nicotine. Duh. Tow the lion, dude.

    It's racist and/or fascist to say that people should be responsible for their own choices in life, after all.

  • ||

    Homeless people suck at geography. There are an awful lot of them suffering through northern winters. With all that free time, you'd think they'd start walking south.

  • Tony||

    It's racist and/or fascist to say that people should be responsible for their own choices in life, after all.

    If you're addicted to something, is it really a choice?

  • ||

    There are alternatives to payday loan places so the poor people that you refer to have options, THEY CHOOSE not to go elsewhere because they don't want to be bothered with financial literacy courses or other "hassles". The "government" put a 36% cap on the interest rates that payday loan shops can charge consumers, so the payday loan shops choose to stop making payday loans, so it's the government's fault? Please, these PREDATORY lenders are in it to make money not help people, otherwise they would continue to offer the loans at a reasonable rate. I say let the people go where they will, but don't complain when you're deeper in debt because of your poor choices.

  • ghost crabs||

    "If you're addicted to something, is it really a choice?"

    There are many addiction clinics that cater to the poor.

  • ||

    yes Tony, it's still a choice...

  • Jordan||

    Nobody is born addicted to nicotine.

  • ||

    You know what's the best idea by far? Don't by things you can't afford! It's so simple! You see that Hummer? Back away from it! If everyone had a fucking brain, no one would be in debt!

  • ||

    If you're addicted to something, is it really a choice?

    Yes - a person can be addicted to sex, but that does not mean he o she will invariably rape a person. And people HAVE stopped using drugs on their own, as statistics have shown (mentioned many times in Reason.)

  • ||

    Just once I'd like to see one of the compassionate politicians supporting the clampdown on rates visit their local payday loan outlet, explain to the hard-working people waiting in line how they're too stupid to make their own decisions and that they need to be protected from themselves, then wait to be thanked for their kind gesture. We can videotape the awkward exchange at post it on You Tube, Lonewacko style!

  • ||

    I kind of view payday loans and lotteries as special taxes on people who are poor at mathematics. Give government a share of the profits on payday loans just as it profits from lotteries, and government will quickly find some other injustice to pick on.

  • ||

    Excellent article, but note that at most payday loan stores across the country a $100 loan costs $15 or $20, not $15 plus a $20 fee, so the total payback is $115 or $120, not $135.

    In my opinion usury laws are an authoritarian tradition which should have been abolished along with the tradition of slavery. They are a gross violation of freedom of commerce, or the right of citizens to engage in honest, mutually agreeable economic transactions (where no dangerous goods are involved).

    The fact is that you cannot draw a line between a "reasonable" and "excessive" rate of interest on a loan. Small-dollar short-term loans, which can be extremely useful for many people and life-saving for some, must carry a high APR because the lender only receives interest on a small amount of money for a short period of time, and needs to recover costs.

    If the free market should work anywhere it is in the field of small loans, because so many people can enter the business with so little expertise or expensive equipment or even capital, if you have good credit, as you can borrow the money which you will lend. Yes, there needs to be strong disclosure requirements and enforcement of debt collection laws, but beyond that the cost of loans is appropriately set by the dynamics of supply and demand.

    Consumer protection is supposed to be about curbing dishonesty and harrassment, not telling merchants and service providers how much they can charge.

    And if lenders are "responsible" for ensuring that borrowers can afford their loans, then why shouldn't other merchants and service providers be similarly responsible? Before long you won't be able to buy anything without the seller being required to investigate your finances to determine if you are making a wise decision, in the view of the state. This is simply 1984 big brotherism.

    People should think twice before jumping on the bandwagon of the current Salem-witch-hunt-like crusade against payday lending.

  • ||

    excellent comment...rational and well thought out.

  • MNG||

    I'm against restrictions on payday lending, it's bad paternalism. The poor find these things useful, we should respect their choices. Liberalism should be about expanding choices for most, not shutting them down.

  • ||

    This is rather non-sequitur, but was it not the fact that Christians prohibited Jews from most professions, rather than Jewish views on usury, that resulted in the concentration of Jews in moneylending?

  • ||

    The "government" put a 36% cap on the interest rates that payday loan shops can charge consumers, so the payday loan shops choose to stop making payday loans, so it's the government's fault?

    Yes, it is the government's fault. If you think 36% interest on unsecured, no qualifying loans is a profitable endeavor, why don't you go into the payday loan business yourself?

    Here's the math: lend $1000 with a 10% default rate. At 36% interest, that's a gross return of $1224.00. But don't forget costs; that's an average of $12/$100 according to the article. That would be $120 in costs, netting you $1104. Congratulations, a 10.4% return. Not much better than the stock market, and hardly worth the business risk considering you'd get more in CDs at a 14% default rate and start losing money at ~17% default rate.

  • robc||

    If you're addicted to something, is it really a choice?

    There are those who think that life
    Has nothing left to chance
    With a host of holy horrors
    To direct our aimless dance

  • ||

    Bob Smith, you are talking about lending $1000 at 36% interest over a period of a year, with a default rate of 10%. That is something of a profitable venture, but it does not apply to payday lenders because they lend to people who do not have good credit and cannot borrow from any other source, by and large, other than overdrafting their bank account or bouncing checks. That is why the lenders make short-term loans to these people, using post-dated checks as collateral, because to make long-term loans to them would result in default rates way higher than 10%. A 36% rate cap would abolish short-term lending and make all loans, other than ones based on charity, unavailable to payday loan customers.

  • ||

    The truth of the matter is that if you can afford to pay the interest you can afford to not borrow it. People need to stop spending money they don't have. You claim it is to pay the electric bill or phone bill but the truth is they spent that money to go out to dinner or a movie or the bar. now they need to borrow money to pay the bills.

  • Steve in Clearwater||

    As a two-income, essentially stable couple, we've used payday loans here about six times a year for past few years.

    In Florida, it's 10% for two weeks and thus we've paid around $400 in fees to help assure we avoid late fees with utilities, landlord or car payments.

    One note however - In Florida, if your collateral check to the lendor bounces, you are not just looking at "collection agencies". You're facing potential criminal charges for passing bad check(s). I'm betting it's that way in most states, which at the end of the day is what helps assure that 90% of loans are repaid on time.

  • zoltan||

    With all that free time, you'd think they'd start walking south.

    Nooooooooooooo, we have enough here in Austin already. The difference is, there are probably way more homeless shelters in the North than South, and no one wants to deal with these summers without air conditioning.

  • ||

    Regulation limiting choice makes things worse. If is slightly off topic but here is an example. The Feds are limiting overdrat fees so now banks are going to start returnign the checks and charging NSF fees. So instead of being overdrawn and having one $30 fee your check will be retunred and you will have two thirty dollar fees and the embarrasment of having to go back and pay the fee where you wrote the check. Sound sliek a good deal to me.

  • maz||

    Many credit card companies charge a fee of $59 for late payments. It would be cheaper to pay the high personal loan fee many times, than that of a late payment, if you had extenuating Circumstances one month. These loans can be dangerous and people can fall into traps; However, that falls under personal responsibility. Many of the large banks that own credit card companies, do not like these loans, because it cuts into their profit margins. They would just rather their friends in Washington Wright bills to help eliminate there competition.

  • ||

    Actually, I'm not totally against limits.

    A a lender can't make money at 36%, maybe they shouldn't be in business. Just like if a investment house can't make money at say 10x leverage or so (instead of 30-50x like they were), then maybe they shouldn't be trying to do what they do.

    I guess what I'm saying, is poor people, and bankers are both to stupid to manage money properly, lol

  • LarryA||

    Please, these PREDATORY lenders are in it to make money not help people, otherwise they would continue to offer the loans at a reasonable rate.

    RTFA. All the lenders that offer what the government (and you) consider "reasonable rates" have to be subsidized to break even.

    There are dozens of payday lenders, and they compete for business. If any of them was making a big profit, the next shop down the street would undercut them.

    I guess what I'm saying, is poor people, and bankers are both to stupid to manage money properly, lol

    If you compare the money-management track record of poor people and bank managers to that of the U.S. Congress, the poor come off looking good.

    "You have to attend a financial literacy class," says Schein

    Haven't had to do that yet, but I have recent experience with required government employment classes. The quality of information and instruction is truly amazing. Not in a good way.

    What consumers really need is protection from government.

  • ||

    Consumers facing a necessary expense and caught short between paydays must often choose between costly and undesirable options: pay the bill now and face bounced check or overdraft protection fees; pay the bill late and incur late penalties; borrow from friends and family; or take out a loan from an unknown Internet lender.
    Removing one option in today's environment will only force consumers into more expensive, less desirable and unregulated alternatives. Payday advances are two week, not annual loans. For each $100 advanced, customers pay a typical fee of $15-$17. Because payday loans are two-week loans they cannot be offered at the same annual rates as annual credit products such as credit cards, auto loans and home mortgages. The only way to reach the much-hyped triple digit APR is to take out one advance and continue to renew the same advance every two weeks for an entire year. State laws and industry best practices do not allow this to happen.

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