Payday loans can help desperate borrowers

Payday loans and cash advances are advertised as a quick and instant loan solution to temporary cash-flow problems. Most borrowers take out these small loans to meet expenses that don’t go away. Since few borrowers improve their economic circumstances before the loan is due, most have to take out another loan or incur fees to postpone repayment.

Research from the Consumer Financial Protection Bureau says that an average of 82% of loans are renewed within the repayment period of 30 days. A study by Pew found that the average borrower takes out eight loans of $375 each per year, spends $520 on interest and is in payday loan debt for five months out of the year – well beyond the two-week obligation payday lenders promote.

According to the Federal Reserve Bank of Kansas City, “the profitability of payday lenders depends on repeat borrowing.” The chronically cash-strapped clientele that these lenders thrive on disproportionately includes those making less than $40,000 per year, people with less than a bachelor’s degree and African-Americans. African-Americans are 23 percent of payday borrowers, but just 12 percent of all American adults.

This asymmetry between the economic vulnerability of borrowers and profitability of lenders opens the door to predatory practices. Lenders usually charge the equivalent of nearly a 400 percent annual rate – which would have been prohibited before states exempted these companies from laws banning small dollar loans and barring usurious interest rates.

Existing regulations vary widely by state and a consistent set of federal rules would help to eliminate abuse. This begins with Congress setting a nonpredatory annual percentage rate cap, as they did with the 36 percent cap set for members of the military in the Military Lending Act of 2006.

In addition, the consumer bureau has authority to issue rules that require lenders to account for a borrower’s ability to repay, limit the duration of payday loan debt allowed in a 12-month period, and restrict lenders from requiring direct access to borrowers’ checking accounts (via post-dated check or electronic access) as a condition of extending credit.

Finally, the repeat business that drives profitability for payday lenders is an indication that the economy isn’t producing adequate wages for people to live on. In addition to direct changes to industry rules, economic policies that broadly help to promote full employment and higher wages would go a long way toward reducing demand for payday loans in the first place.