Despite mounting evidence showing short-term loans are a help to many people, states have been implementing laws severely limiting or banning certain types of short-term loans, often called payday loans. Several states this year will launch new regulations on the industry, some even taking a direct role in providing the loans themselves.
Payday borrowers typically have no credit history, a bad credit history, or other reasons for being denied access to conventional lenders. Because of the high risk of lending money to such people, the money is loaned at interest rates or fees higher than those charged by traditional institutions lending to traditional-risk consumers.
Payday lending bans often come with unexpected side effects. In a study by the Federal Reserve Bank of New York, researchers found when Georgia and North Carolina banned payday lending, people in those states “bounced more checks, complained more to the Federal Trade Commission about lenders and debt collectors, and filed for Chapter 7 bankruptcy protection at a higher rate.”
Restrictions in Washington
In Washington State, a bill signed into law last year by Gov. Chris Gregoire (D) places several restrictions on the payday loan industry. The law limits the size of a payday loan to 30 percent of a person’s monthly income, or $700, whichever is less. It also prohibits a borrower from having multiple loans from different lenders, allows a maximum of eight loan in 12 months, and sets up a database to track the number of loans people take out.
”What they don’t like is the eight-loan limit. A lot of companies make loans because people take out another loan, and another loan; that’s where the revenue stream comes from,” said Deborah Bortner, director of Consumer Services at Washington’s Department of Financial Institutions, in a press statement. ”The Legislature clearly wanted to stop the cycle of debt for some of these people who went from lender to lender borrowing from one to pay the next one.”
Payday lending industry leaders argue the loans serve an important purpose by providing consumers with short-term emergency loans when other sources of financing are unavailable. This enables people to avoid bounced checks and late fees on debts, both of which further damage a blemished credit history.
Joe Brown, general counsel for the Check Masters chain of payday lenders, told the Seattle Post-Intelligencer: ”There’s still high demand for our product but we won’t be able to feed it,” adding the new law ”will push people to other forms of short-term credit” such as online lenders that operate off shore.
The Virginia State Employee Assistance Fund partnered with the Virginia Credit Union in 2009 to create the Virginia State Employee Loan Program. The program offers small loans ranging from $100 to $500 to state employees. The loans are offered at an annual percentage rate of 24.99 percent.
State employees who access the program repay their loans through direct withdrawals from their paychecks over a six-month period. About 3,000 employees used the program last year.
Gov. Tim Kaine (D) is promoting Virginia’s program as a model for the entire country.
“It is keeping state employees from having to rely on these super, you know, usurious payday lenders, and instead there’s a better product within state government with a 24 percent interest rate instead of a 400 percent interest [rate],” Kaine said on WTOP Radio in Washington, DC.
San Francisco has taken a similar approach to Virginia’s and is working with local credit unions to offer short-term loans to its citizens in a program called Pay Day Plus SF. Unveiled by San Francisco mayor Gavin Newsom in December 2009, the new program will allow citizens to borrow up to $500 and spread out payments over six months. The interest rate for these loans will be 18 percent.
Matthew Glans ([email protected]) is a legislative specialist in insurance and finance at The Heartland Institute.
“Payday Holiday: How Households Fare After Payday Credit Bans,” The Federal Reserve Bank of New York: http://www.newyorkfed.org/research/staff_reports/sr309.html.