Payday Loans: Filling the Gap?

Published March 2, 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.

Matthew Glans ([email protected]) is a legislative specialist for The Heartland Institute.