A recent article published on the blog for the Federal Reserve Bank of New York analyzes the recent attention given to payday loans by the Consumer Financial Protection Bureau. The article evaluates the various objections raised by the CFPB and others seeking to heavily regulate or even outlaw these short term, high interest loans. The authors conclude that most common objections do not hold up under scrutiny, and that much research is needed before onerous rules are laid upon an industry that serves more than 10 million customers each year.
The first complaint against payday lenders is their high prices. The typical brick-and-mortar payday lender charges $15 per $100 borrowed per two weeks, which amounts to an annual interest rate (APR) of 391 percent. That is a high price but, according to the authors, not an unfair one. They cite a recent study indicating that strong competition among payday lenders actually tends to keep prices down. Also, payday lenders, like other lenders, face risks. The authors cite an FDIC report using payday lender data that concluded the combination of fixed operating costs and loan loss rates justify a large part of the high APRs.
Another complaint leveled against payday loans is that the fees increase exponentially when consumers roll their loans over from month to month. However, payday lenders do not charge refinancing or rollover fees, as with mortgages, and the interest doesn’t compound. Interest on payday loans is actually expressed linearly, not exponentially.
Finally, payday lenders have been accused of preying upon minority borrowers. The authors again turned to the relevant research to defend payday lenders. It is well known that payday lenders tend to locate in lower income, minority communities. However, according to a recent Federal Reserve study, they do so because of their financial characteristics and not their racial composition. Only people who are having financial problems and can’t borrow from mainstream lenders demand payday credit, so payday lenders locate where such people live or work.
The one aspect of payday loans that the authors believe required additional scrutiny is rollovers, or the tendency of a loan to be taken out, repaid, and taken out again within 14 days. Twenty percent of new payday loans are rolled over six times such that borrowers wind up paying more in fees than the original principal. Though this is an expensive proposition, there is no evidence that people are actually being deceived. The authors claim that if chronic rollovers reflect behavioral problems in consumers, capping rollovers would benefit those consumers. However, they said that far more research is necessary.