Policy Documents

Payday Loan

Matthew Glans –
February 1, 2008

Several states are considering severe limits or even bans on certain types of short-term loans, often called "payday loans." The practice of payday lending, often including a high interest rate or substantial collateral, is indeed quite risky--but not only for an under-educated consumer.

Private enterprise takes on enormous financial risk when it loans money, at any rate or fee schedule, to a consumer with no credit history or a severely blemished one. Consumers facing a sudden, staggering expense with no credit history or conventional access to liquid funds spurred creation of a self-regulating market: An unusually high-risk portfolio of consumers can get loans, but at interest rates or fees higher than those charged by traditional institutions lending to traditional-risk consumers.

While payday loans are controversial, they serve an important purpose in the market: to provide short-term emergency loans when other sources of financing are unavailable. These loans clearly are more desirable than bounced checks and late fees, which only further damage a blemished credit history.

Some advocacy groups claim payday lending is inherently predatory, since statistics show the highest percentages of consumers who use such loans are poor or undereducated. But several of these studies have been proven flawed. Moreover, this seems to be a case of the chicken and the egg: Advocacy groups draw a connection between payday lending and the cause of poverty and poor education; in reality, payday lenders are serving a group of consumers essentially blacklisted from more mainstream lending practices.

In order to keep you updated on this important issue, the following articles address some of these concerns and examine the payday loans debate from a free-market perspective.


Legal Loan Sharking or Essential Service? The great "payday loan" controversy http://www.reason.com/news/show/28380.html Michael Lynch of Reason magazine examines the payday lending debate and addresses how payday loans compare in cost to bank overdraft and late fees.

If Only Understood -- Payday Loans
http://www.townhall.com/columnists/RyanKrugerandMikeCatalano/2006/12/20/if_only_understood_%e2%80%93_payday_loans&Comments=true
Ryan Krueger, a money manager and co-founder of Krueger & Catalano Capital Partners, writes about the misunderstood nature of payday loans, describing their benefits and their longevity in the marketplace.

The Debate Room: Fleecing Poor Americans, A Pro-Con Debate on Payday Loan Bans
http://www.businessweek.com/debateroom/archives/2007/05/stop_fleecing_p.html
This article from Business Week presents a pro-con debate on payday loan bans, between Nouriel Roubini of the Stern School of Business and Tyler Cowen of George Mason University.

Myths vs. Reality of Payday Loans
http://www.cfsa.net/myth_vs_reality.html#1
Written by the Community Financial Services Association of America, this article addresses some of the negative myths against payday loans.

In Defense of Payday Lending
http://www.mises.org/freemarket_detail.aspx?control=454
Tom Lehman, assistant professor of economics at Indiana Wesleyan University, critically examines the payday lending debate, responding to the arguments of payday lending opponents and analyzing the role of government regulation in the expansion of the payday lending industry.

Who Uses Payday Loans? Not Who You Might Think.
http://hamptonroads.com/2008/01/who-uses-payday-loans-not-who-you-might-think
Examines the diversity of people who use payday loans, demonstrating a wider consumer base then critics claim.

Mayday for Payday Loans
http://webreprints.djreprints.com/1680840349966.html
This article describes the efforts of some states to ban or tightly regulate payday loans. Despite these efforts, the article notes, payday markets are persistently resilient.

Payday Holiday: How Households Fare after Payday Credit Bans
http://www.newyorkfed.org/research/staff_reports/sr309.html
This article describes the effect of payday loan bans on individual households. The author examines the claim that payday loans are preferable to alternatives, including credit card late fees and overdraft charges.

Cap on Payday Loans Would Hurt Those Most in Need http://www.dailypress.com/news/opinion/dp-ed_payday_0107jan07,0,4377218.story
This article, written by an economist from the Employment Policies Institute, describes the negative effect a payday loan ban could have on poorer working families.


For further information on this and other free-market topics, visit The Heartland Institute's Web site at http://www.heartland.org and PolicyBot™, Heartland's free online research database.

If you have any questions about this issue or The Heartland Institute, you may contact me at 312/377-4000 or mglans@heartland.org.