The Debate - Opponents vs. Proponents

Payday loans continue to be one of the most controversial subjects in the financial lending industry. More and more states are enacting legislation to either ban these companies outright or to place tighter controls over the way they conduct their business.

Opponents of quick loans

Draining money from low-income communities

While many average-income individuals are now using payday type loans as a means of getting quick cash, the vast majority of payday loan customers are low-income people with very few assets. These consumers have little hope of qualifying for a traditional personal loan so the idea of being able to get a cash loan while supplying very little paperwork or personal information is very appealing. However, the extremely high interest rates charged by payday loan companies significantly drain the assets of low-income communities.

Exploiting financial hardship for profit

Payday lenders have come under attack from various groups, including the Consumers Union, which charge the payday loan industry with making enormous profits from the financial hardships of cash-strapped consumers. They also say that these payday loan companies target young and poor consumers, especially those people living near military establishments and in low-income communities. Consumer groups claim that many, if not most, of typical payday loan borrowers do not fully understand how the high interest rates charged to them often lead to a “debt-cycle” which is hard to break. This occurs when the borrower cannot fully repay the loan at the end of the two week period and then has to renew the loan, with additional fees charged. Critics repeatedly state that payday loans take unfair advantage of the poor when compared to middle class consumers, who may be charged about 25% on their credit card purchases.

Aggressive collection practices

A payday lender legally has to use the same financial industry standard collection practices used to collect other types of debt. When an individual uses a payday type loan, a post-dated personal check is given to the lender for the amount of the loan, including any fees. Normally, the check is dated for two weeks ahead or the borrower’s next payday. At that time, the lender will deposit the check and the loan will be paid off in full. But if there are insufficient funds in the checking account, the check will bounce. Some payday lenders have threatened these delinquent borrowers with criminal prosecution for check fraud. However, many states do not allow this practice.

Ignoring legal restrictions

Many states limit the amount of interest that payday loan companies can charge borrowers. But many payday lenders willfully ignore these limits and continue to overcharge their customers. Global Payday Loan is one such company. In May of 2008, the Illinois Department of Financial and Professional Regulation fined this company $234,000- the largest fine against a payday lender in Illinois history. A customer had borrowed $300 and had repaid $360 ($13.50 more than the company was legally allowed to collect) but Global Payday Loan sent her warnings about her “seriously delinquent” account and that her unpaid balance was $630.

Pricing structure of payday loans

The payday loan industry strongly defends their high interest loans, comparing them to other loans such as mortgages. They point out that a one week loan for $100 with a 20% interest rate would only generate about $0.38 in profit. This wouldn’t even cover their loan processing costs, so they claim. Critics argue that payday lenders have very little in the way of costs with their loans. Payday lenders generally only look at a borrower’s pay stubs for proof of income. They do not run credit checks or analyze a borrower’s ability to repay the loan.

Proponents of quick loans

Charges are in line with costs

Many proponents of payday loans argue that the high interest rates charged by these lenders are necessary due to the high rate of default. Based on the annual reports of some publicly traded payday loan companies, loan losses can exceed 15% of total loan revenues. Payday lenders claim that they encounter a different set of problems when dealing with borrowers than do more conventional financial lenders. These include customers who write fraudulent checks for their loans or call their banks to get a “stop payment” issued on the checks or even close their checking accounts altogether.

While critics agree that the default rate on payday loans is higher than on traditional loans, they point out that the enormous growth the industry has enjoyed over the past decade has also brought about a huge increase in overall profitability. Consumer advocates continue to condemn payday loans largely due to the fact that lenders prey on financially troubled consumers and make their situations worse than before.

Markets provide services otherwise unavailable

For those people who want to do away with government regulation of payday loan companies, the main argument is that these companies provide a much needed financial resource to those customers who have little or no options of getting a traditional loan. These proponents claim that these potential borrowers would be forced to go to loan sharks or other illegal sources if they could not have access to payday loans. They also state that the boom of the payday loan industry has allowed low-income consumers to receive loans when normally they would have no means to do this.

Household welfare increased

A report released by the Federal Reserve Bank of New York stated that payday loans should not be considered predatory due to the fact that in many cases, household welfare actually increased. However, it was noted that payday loans are expensive and that borrowers are more likely to be lower-educated and have uncertain income. Studies have shown no correlation between payday loans and an increase in bankruptcy filings.

Property crime decreased

A study published in 2010 found that neighborhoods which contained payday loan companies or had a higher concentration of them actually had lower property crime rates when compared to wealthier neighborhoods that did not have these businesses.

An aid in disaster areas

Professor Adair Morse of the University Of Chicago Booth School Of Business conducted a research study in 2009 and concluded that in areas which had been hit by some form of natural disaster and where payday loans were available, consumers recovered and fared much better than in disaster areas which contained no payday loan businesses. Fewer foreclosures were recorded in the payday loan areas. The study also found that the number of people being treated for drug and alcohol addictions was much less in the areas served by payday loan lenders.