Payday loans are expensive, a recent Wichita Eagle articles tells us. If someone needs to borrow money and has access to a loan from almost any other source, they should avoid payday lenders. But the reality is that there are people who have poor credit and are not able to obtain credit through the usual channels such as banks, credit unions, credit cards, and family and friends. These people may have but one source for loans: the maligned payday lenders.
Why can’t these people borrow from traditional, “legitimate” lenders? The answer is that making small loans to people who have a history of credit problems is expensive. Wishing it weren’t so and imposing government regulation won’t change this fact.
Community activists call for existing banks and financial institutions to offer small loans at reasonable interest rates. One institution in Wichita, Communities United Credit Union, did just that. But earlier this year it failed after suffering losses from bad loans, providing more evidence that it is costly to offer small loans to credit-challenged customers.
If existing financial institutions are to make small loans to credit-challenged borrowers, they should do so only with the reasonable expectation of earning profits from these loans. To do otherwise is to abandon their responsibility to their investors, and, should I learn that my bank or a bank I had invested in was making risky loans without being compensated for the risk, I would withdraw my investment in that bank.
An irony is that existing government regulation may be a contributing factor as to why payday loans are so prevalent. In an Wichita Eagle article from earlier this year, we read “Some bankers are reluctant to offer them [small loans] because their industry is so tightly regulated …” These regulations either prohibit or add to the cost of making small loans, bankers say.
Furthermore, usury laws, which limit the interest that banks and other traditional lenders may charge, are perhaps too restrictive. If traditional banks and credit unions could charge, say 25%, 40%, or even 50% for small loans, they might find it profitable to do so. An interest rate of 50%, while high, is certainly preferable to the several hundred percent rates that payday loan borrowers who roll over their loans pay.
Those who call for a limit on the interest rate that payday lenders can charge may very well drive these lenders out of business. I suspect that is their unstated goal. If they are successful, where will credit-challenged borrowers go for loans? As shown above, traditional lenders are not serving these borrowers.
A group named Sunflower Community Action says that payday lenders prey on poor people who have few financial options. I believe this group is misinformed on two points. First, the transaction between the borrower and lender is voluntary. Neither party is coerced, so there is no “preying.” Second, it is true that poor people have few options. Eliminating payday loans removes one more option, an option that evidently some people use. To its credit, this group promotes financial education and literacy, which is the best weapon to fight the cycle of poverty that some find themselves stuck in.
Definitely some good advice here. Avoid these type of places like the plague unless you have absolutely no other options. They wil only harm your financial situation more than they will help…
Here in the UK Payday loans are on the increase. This could be due to the current credit crunch but when you look at the interest rates associated with these loans you can only think there is only one winner here.
Although it has to be said that lenders are still very cautious about offering such loans, with application criteria almost as stringent as that for a secured loan.
According to a recent article in The Wichita Eagle, the number of payday lenders in Kansas has grown exponentially in recent years from 53 statewide in 1993 to 436 in 2006 and that number continues to grow. While some states have passed laws to limit the amount of interest payday lenders can charge consumers or shut them down completely, lawmakers in Kansas seem to feel as though it is not the state’s responsibility to babysit consumer’s checkbooks or monitor their financial decisions.
Very interesting blog, you got a new reader for sure!