payday loans

payday loans:

A payday loan (also called a payday advance) is a small, short-term unsecured loan, "regardless of whether repayment of loans is linked to a borrower's payday".^[1][2][3] The loans are also sometimes referred to as "cash advances", though that term can also refer to cash provided against a prearranged line of credit such as a credit card. Payday advance loans rely on the consumer having previous payroll and employment records. Legislation regarding payday loans varies widely between different countries and, within the USA, between different states......

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To prevent usury (unreasonable and excessive rates of interest), some jurisdictions limit theannual percentage rate (APR) that any lender, including payday lenders, can charge. Some jurisdictions outlaw payday lending entirely, and some have very few restrictions on payday lenders.

For a $15 charge on a $100 2-week payday loan, the annual percentage rate is 26 × 15% = 390%; the usefulness of an annual rate (such as an APR) has been debated because APRs are designed to enable consumers to compare the cost of long-term credit and may not be meaningful in cases where the loan will be outstanding for only a few weeks. Nevertheless, careful scrutiny of the particular measure of loan cost quoted is necessary to make meaningful comparisons.^{[citation needed]}

In practice, consumers do not find value in either APR or EAR, but rely on the flat pricing signal in dollars and cents when determining whether or not to use a payday loan.^{[citation needed]}

Payday loans carry substantial risk to the lender; they have a net default rate of 6%,^[4] and according to one study, defaults cost payday lenders around a quarter of their annual revenue.^[5]

The basic loan process involves a lender providing a short-term unsecured loan to be repaid at the borrower's next payday. Typically, some verification of employment or income is involved (via pay stubs and bank statements). Individual companies and franchises have their own underwriting criteria.

In the traditional retail model, borrowers visit a payday lending store and secure a small cash loan, with payment due in full at the borrower's next paycheck. The borrower writes a postdated cheque to the lender in the full amount of the loan plus fees. On the maturity date, the borrower is expected to return to the store to repay the loan in person. If the borrower does not repay the loan in person, the lender may redeem the check. If the account is short on funds to cover the check, the borrower may now face a bounced check fee from their bank in addition to the costs of the loan.

In the more recent innovation of online payday loans, consumers complete the loan application online (or in some instances via fax, especially where documentation is required). The loan is then transferred by direct deposit to the borrower's account, and the loan repayment and/or the finance charge is electronically withdrawn on the borrower's next payday.

[edit]User demographics and reasons for borrowing

According to a recent study by the Pew Charitable Trusts, "Most payday loan borrowers are white, female, and are 25 to 44 years old. However, after controlling for other characteristics, there are five groups that have higher odds of having used a payday loan: those without a four-year college degree; home renters; African Americans; those earning below $40,000 annually; and those who are separated or divorced."

In a study, "An Analysis of Consumers’ Use of Payday Loans" by Gregory Elliehausen, Division of Research of the Federal Reserve System and Financial Services Research Program at The GWU School of Business, 41% earn between $25,000 and $50,000, and 39% report incomes of $40,000 or more. 90% have a high school diploma or better, with 54% having some college or a degree.

[edit]Criticism

[edit]Draining money from low-income communities

Many people who use it are low-to-middle income people with few assets. These individuals are least able to secure normal, lower-interest-rate forms of credit. Since payday lending operations charge higher interest-rates than traditional banks, they have the effect of depleting the assets of low-income communities.^[6]

This analysis, however, does not account for the assets purchased with the debt, which are often necessities, and for which the consumer would otherwise resort to an even more expensive and more depleting loan product.

[edit]Aggressive collection practices

In US law, a payday lender can use only the same industry standard collection practices used to collect other debts, specifically standards listed under the Fair Debts Collection Practices Act.

In all cases, borrowers write a post-dated check (check with a future date) to the lender; if the borrowers don't have enough money in their account, their check will bounce.

Payday lenders will attempt to collect on the consumer’s obligation first by simply requesting payment, as they would rather retain a customer who normally pays on time but may have experienced an unexpected obstacle to repayment. If internal collection fails, some payday lenders may outsource the debt collection, or sell the debt to a third party.

A small percentage of payday lenders have, in the past, threatened delinquent borrowers with criminal prosecution for check fraud.^[7]This practice is illegal in many jurisdictions and has been denounced by the CFSA, the industry's trade association.

[edit]Proponents' stance

[edit]Charges are in line with costs

A study by the FDIC Center for Financial Research^[8] found that “operating costs are not that out of line with the size of advance fees” collected and that, after subtracting fixed operating costs and “unusually high rate of default losses,” payday loans “may not necessarily yield extraordinary profits.”

Based on the annual reports of publicly traded payday loan companies, loan losses can average 15% or more of loan revenue. Underwriters of payday loans must also deal with people presenting fraudulent checks as security, ordering a check stopped, or closing their account.^{[citation needed]}

Annual reports of publicly traded payday loan companies demonstrate the net profit margins of payday lenders are in the 10-12% range.

[edit]Markets provide services otherwise unavailable

Opponents of excessive government regulation of payday loan businesses argue that some individuals that require the use of payday loans have already exhausted or ruined any other alternatives. Such consumers could potentially be forced to illegal sources if not for payday loans. Tom Lehman, an advocate of payday lending, said,

"[P]ayday lending services extend small amounts of uncollateralized credit to high-risk borrowers, and provide loans to poor households when other financial institutions will not. Throughout the past decade, this "democratization of credit" has made small loans available to mass sectors of the population, and particularly the poor, that would not have had access to credit of any kind in the past...."^[9]

Lehman attacked proponents of increased regulation of the lending industry, arguing that,

"These allegations against the payday-lending industry are largely without merit, and generally reflect the views of "do-gooder" anticapitalist elites who abhor the "messy" and unplanned outcomes in low-income consumer finance markets. Rather than seeing payday lending practices as a creative extension of credit to poor households who may otherwise be without loans, these critics see it as yet another opportunity for government intervention in the name of "helping" the poor."^[9]

[edit]Household welfare increased

A staff report released by the Federal Reserve Bank of New York concluded that payday loans should not be categorized as "predatory" since they may improve household welfare.^[10] "Defining and Detecting Predatory Lending" reports "if payday lenders raise household welfare by relaxing credit constraints, anti-predatory legislation may lower it." The author of the report, Donald P. Morgan, defined predatory lending as "a welfare reducing provision of credit."

Petru Stelian Stoianovici, a researcher from The Brattle Group, and Michael T. Maloney, an economics professor from Clemson University, found "no empirical evidence that payday lending leads to more bankruptcy filings, which casts doubt on the debt trap argument against payday lending."^[11]

[edit]Aid in disaster areas

A 2009 study by University of Chicago Booth School of Business Professor Adair Morse^[12] found that in natural disaster areas where payday loans were readily available, consumers fared better than those in disaster zones where payday lending was not present. Not only were fewer foreclosures recorded, but such categories as birth rate were not affected adversely by comparison. Moreover, Morse's study found that fewer people in areas served by payday lenders were treated for drug and alcohol addiction.

[edit]Payday loans around the world

[edit]Australia

Main article: Payday loans in Australia

The Australian states of New South Wales and Queensland have imposed a 48%-APR maximum loan rate, including fees and brokerage.^[13][14]

[edit]Canada

Main article: Payday loans in Canada

Payday loans in Canada are limited by usury laws, with any rate of interest charged above 60% per annum considered criminal according to the Criminal Code of Canada. In addition, the provinces of British Columbia and Saskatchewan have imposed specific regulations on payday loans, including lower interest rate caps.

[edit]UK

Main article: Payday loans in the United Kingdom

Payday loans in the United Kingdom are a rapidly growing industry, with four times as many people using such loans in 2009 compared to 2006 - in 2009 1.2 million people took out 4.1 million loans, with total lending amounting to £1.2 billion.^[15] The average loan size is around £300, and two-thirds of borrowers have annual incomes below £25,000. There are no restrictions on the interest rates payday loan companies can charge, although they are required by law to state the effective annual percentage rate (APR).^[15]

[edit]United States

Main article: Payday loans in the United States

Payday lending is legal and regulated in 37 states. In 13 states it is either illegal or not feasible, given state law.^[16] When not explicitly banned, laws that prohibit payday lending are usually in the form of usury limits: hard interest rate caps calculated strictly by annual percentage rate (APR).

As for federal regulation, the Dodd–Frank Wall Street Reform and Consumer Protection Act gave the Consumer Financial Protection Bureau specific authority to regulate all payday lenders, regardless of size. Also, the Military Lending Act imposes a 36% rate cap on tax refund loans and certain payday and auto title loans made to active duty armed forces members and their covered dependents, and prohibits certain terms in such loans.