Business Bogeyman Du Jour: Payday Lenders

There appears to be some momentum in the upcoming Iowa legislative session to restrict payday loans in the state. Sometimes called a “payday advance,” payday loans are short-term (usually two-week) loans where the borrower issues a post-dated check to the lender.

According to the Community Financial Services Association of America (CFSA), the industry organization for payday lenders, the typical fee charged by payday lenders is $15 per $100 borrowed. So a customer wishing to borrow $100 would write a check to the lender for $115. The lender would then give the borrower $100 cash. Two weeks later the lender would cash the customer’s check, keeping the extra $15.

This simple arrangement has managed to stir the ire of legislators across the country, including Iowa. State Senator Joe Bolkcom, D-Iowa City, head of the Senate Ways and Means Committee, said, "The payday loan industry is our local counterpart to the crooks on Wall Street." Other critics, such as Tom Chapman, executive director of the Iowa Catholic Conference, point out that interest rates on payday loans can run as high 400 percent. "We believe these types of interest rates are unjust and should be outlawed," said Chapman. "Instead of promoting the financial stability of consumers, the system actually creates a financial incentive in the failure of Iowa families rather than their success."

But CFSA’s website points out: “The typical fee charged by payday lenders is $15 per $100 borrowed, or a simple 15 percent for a two-week duration. The only way to reach the triple digit APRs [annual percentage rates] quoted by critics is to roll the two-week loan over 26 times (a full year). This is unrealistic considering that many states do not even allow one rollover. In states that do permit rollovers, CFSA members limit rollovers to four or the state limit—whichever is less.”

If a payday loan customer somehow did carry his loan for a whole year, how would that APR compare to other alternatives to low-income consumers? Again from the CFSA:

$100 payday advance with a $15 fee = 391% APR
$100 bounced check with $54 NSF/merchant fees = 1,409% APR
$100 credit card balance with a $37 late fee = 965% APR
$100 utility bill with $46 late/reconnect fees = 1,203% APR.

So compared to these and other “quick cash” alternatives, like pawn shops, payday loans are not terribly out of line. If consumers with poor credit ratings could get small, quick loans elsewhere (such as conventional banks) they no doubt would. Since the payday lenders offer an apparently popular service that consumers can’t get elsewhere, why shouldn’t they be able to charge a premium price for it?

So, what is the problem? The words of State Representative Janet Petersen, D-Des Moines, head of the House Commerce Committee, who favors new restrictions on payday lenders, offer some clues. Petersen says that, by restricting payday loans, “lenders will be forced to take some responsibility for ensuring that Iowans don't end up in a vicious debt cycle." [Emphasis added.]

In the minds of people like Peterson, consumers are ignorant sacks of meat that mindlessly throw their money to greedy, unscrupulous businessmen (in this instance payday lenders). Without smart and benevolent legislators like Peterson and Bolkom to protect them every moment of the day, the people they represent are little more than sheep to be shorn by capitalist predators. If anyone is to "take some responsibility" for the lives of Iowans, it must be the lenders (and the legislators) who apparently draw from a more intelligent gene pool than mere citizens.

Experience in other states has shown that restrictions on payday lenders result in fewer of those lenders. This would obviously mean fewer payday loans available to Iowans. Therefore, restricting payday lenders might allow liberal lawmakers to slap each other on the back for helping the “little guy,” but without reducing the NEED for or providing some new alternative to payday loans, they have only succeeded in worsening the little guys’ circumstances.