Payday loans are a fairly new phenomenon sweeping the US. A niche formally served by seedy loan sharks has now been classed up and legalized. Sadly, this has not changed the fact that there is NEVER a good reason to use a payday loan operation. While this might seem like an elitist point of view, critically analyzing the length of loans, cost of loans, and loan situations will prove this out.
Who Uses Payday Loan Services and Why
Payday loan services are primarily used by the poor and people who have had some kind of credit trouble, i.e. bankruptcy, repossession, delinquency, etc. Some people use these services as a legitimate source of emergency funding. In order to pay for things like funerals, hospitalizations, or other emergency services, some people feel like they have no other option than payday loans.
In the United States, poor people and people in emergency situations pay more for just about everything. Studies have shown that the poor pay more for all types of loans, insurance, and even everyday goods like groceries. This is a result of their lower income and lack of financial education. Clearly, higher income does not necessarily increase financial literacy; however, higher income does decrease interest rates paid, increase disposable income to cover emergencies, and allow people more room for financial errors.
The Case Against Payday Loans for All
Payday loan companies advertise their service as emergency assistance for families in need. It would seem logical that they would have systems in place to ensure that only families in need were able to access their services. This is not the case.
Payday loan companies expect to service customers who have no other option for loan funding. Their short payment window allows for the maximum return on their investment. Short of outright fraud, payday lenders are guaranteed their money and a very hefty return. This hefty return is where problems arise.
Payday lenders charge interest rates well above the 20% rates of credit cards. Borrowers who get behind and decide to rollover their loans to the next pay period can end up paying nearly 50-80% interest. Interestingly enough, payday lenders only lend up to a certain percentage of a borrower's paycheck. After several months of rollovers, the borrower is quickly in a position of owing more in interest payments than the original principal of the loan, and at times owing more than he/she makes in a pay period.
The issue comes down to this: can an emergency wait two weeks and/or can a borrower access other funds? Most emergencies have some time pressure, so if the situation is truly an emergency it probably cannot wait two weeks. The access to other funds is where the solution to the payday loan problem is found. There are a surprisingly large number of community-based emergency funding sources. Local churches and charities typically offer emergency assistance. Keeping in mind most payday loans are less than $500, it would seem that true emergencies could be worked out. Be it negotiation with a hospital, funeral home, or other emergency care provider, there are so many ways to work things out. Additionally, there is government assistance for these things as well. Most people who use payday lenders are not aware of other options.
The Real Payday Loan Problem
Payday loans are targeted toward people with poor credit. This means people who are accessing these ultra high interest loans have already proved to be poor money managers. Expecting them to use this system “wisely” is tantamount to expecting a person with no medical training to do complex life saving brain surgery. Until there are stricter requirements around who can access these funding sources, how often, and for what purpose, payday lenders will continue to loot the poor segment of the US population. While these may seem like harsh words, looking at the profit margins of payday loan firms bears this out. Usury laws are in place to protect people from these kinds of practices.
