by James Frauenberg II

April 04, 2008

As legislators in Ohio consider joining Georgia and North Carolina, two states that took action to make it unaffordable and impossible for payday lenders to conduct business, let's consider the results of these actions with substance instead of rhetoric. What really happens to people in states that ban payday loans?

Consumers are not doing fine and, while some credit unions and churches are starting to offer payday loans, they come nowhere close to meeting the demand, according to researchers working for the Federal Reserve Bank of New York as well as information from scholars at the University of North Carolina.

"Payday Holiday: How Households Fare after Payday Credit Bans," a working paper by Federal Reserve Bank of New York Research Officer Donald P. Morgan and Cornell University graduate student Michael R. Strain, rebuts unsubstantiated claims that consumers fare better without the option of payday loans. In fact, the study concludes that the elimination of payday loans results in increased credit problems for consumers.

What kinds of credit problems? According to Morgan and Strain, consumers "bounced more checks, complained more about lenders and debt collectors, and have filed for Chapter 7 bankruptcy at a higher rate." Additionally, the working paper says, "To stave off bankruptcy, distressed borrowers pawned or sold assets.

"Most of our findings contradict the debt trap hypothesis," the study says. "Our findings show that [payday loans] help to avoid more quotidian disasters, like bouncing a mess of checks or getting hassled at work by debt collectors."

The University of North Carolina Center for Community Capital conducted a survey to determine how North Carolina consumers fared without the option of payday loans. Their conclusions do not match the actual findings. In fact, the majority of people surveyed had never used a payday loan or even experienced a financial hardship in the previous three years. Because they never used or needed the product in the first place, it's logical that they did not miss it when it was gone. Only 23 of the 401 surveyed were former payday loan customers. Of those, only five said that prohibiting payday lending has had a positive effect on their household.

The North Carolina survey demonstrates a strong demand for credit to cover small, unexpected expenses between paydays. Many consumers don't have savings, friends, family or a church from which to borrow. When asked how they handled their most recent financial crisis, the most frequent response was "did not pay/paid the expense late." Other telling responses included "bounced checks/used overdraft" and "used a creditcard/cash advance." Considering the fees for those products can be double that of a payday loan, a payday loan may have been a better option for those consumers.

According to the survey, of those who chose not to pay a bill, 60 percent faced costly or damaging consequences. Ten percent said they "had utilities disconnected, went without a prescription medication, or had a damaged credit rating." The remaining 50 percent incurred late fees and charges, with some respondents saying their "bill was turned over to a collection agency or that they faced repossession or bankruptcy." The option of a payday loan could have prevented these negative outcomes.

Clearly, it is a mistake for state governments to deny consumers the option of payday loans. When used wisely, a payday advance can be a good option for consumers needing short-term credit. If asked, consumers will tell you that payday loans help them avoid more costly bounced check and overdraft protection fees, late payments on bills and the embarrassment or hassle of asking family for money or pledging personal possessions for short-term loans. Taking away the option only forces them into the products they had previously tried to avoid.

We want customers to use payday advances wisely, and we want them to be a solution, not a problem, for individuals who need low-dollar, short-term credit. To that end, we have taken a significant step forward in our ongoing commitment to responsible lending.

Our members put notices on all of their advertising materials to advise people only to use payday advance for short-term needs. And we've implemented an extended payment plan, offered at no charge, for the small number of customers who need extra time to pay back their loan when due.

We've recently announced an enhancement to our Best Practice on fee disclosure that requires members of the Community Financial Services Association to prominently display all fees and annual percentage rates on easy-to-read posters in all their stores and on their Web sites.

The payday lending industry isn't perfect. Not all stores conform to the tough rules imposed on CFSA members. And sometimes, payday loans are not the right choice for a customer. But denying Ohioans the option of a well-regulated industry with transparent fees, payment options, and tough consumer protections is not the solution-as the recent studies show.

As Stanford economist Thomas Sowell pointed out several years ago, you can't make people better off by taking away their options. These two recent studies prove this point.

Frauenberg is president of the Ohio Association of Financial Service Centers and is senior vice president of Checksmart, a payday lender headquartered in Dublin, Ohio. Checksmart operates 103 stores in the Buckeye State and employs 778 hard-working Ohioans.

3/27/2008

By: Marc Kilmer

Ohioans did not send legislators to Columbus to make their personal financial decisions for them. Considering the poor state of Ohio's budget, it seems ironic that some in Columbus think their time is best spent focusing on the financial choices of others. Unfortunately, a few legislators want to spend the General Assembly's time targeting payday lending instead of fixing the serious tax and budget problems which plague the state.

Payday lending involves borrowers taking short-term loans by putting up future paychecks as collateral. It is an increasingly popular option for some, although it has found critics looking to blame some of Ohio's economic problems on it. In reality, though, these loans are not a "net drain" on our economy. Payday loans are the same as any other loan - a borrower gets one amount of money with an agreement to pay a larger amount of money back to the lender.

The main difference between payday loans and other loans is that payday loans are for very short time periods - usually two weeks - and are offered to people who have credit issues and other financial problems. As economists who study lending will tell you, these types of loans have high overhead. The default rate is also much higher than other loans. What that translates into is relatively high fees on loans. But just because an interest rate looks like a lot of money does not mean that it is unjustified. People want these short-term loans and they willingly agree to pay the fees and interest charged. How much are these fees? In a recent column, Representatives Bill Batchelder and Robert Hagan claimed that these lenders charge a "391 percent interest rate." However, a closer look finds something different.

In Ohio, almost all payday lenders charge borrowers $15 per $100 borrowed. That is an interest rate of 15 percent. If one assumes that a borrower takes a payday loan for a year, then it is possible that the yearly interest rate could add up to 391 percent. But since these loans only last for two weeks, the only accurate way to describe the interest rate is 15 percent.

Reps. Batchelder and Hagan are also forwarding legislation to regulate these loans. They say the bill merely caps unreasonable rates. And, they say "efficient businessmen" can still make a profit under their proposal to allow lenders to only charge $1.50 per $100 borrowed on a two-week loan. However, testimony from people who actually run these businesses and economists who study this industry is almost unanimous in saying that current rates and fees are essential to pay the lenders' overhead. Of course, there is nothing stopping lenders now from charging the interest rate proposed by Reps. Batchelder and Hagan.

If consumers were really being exploited by lenders as these legislators claim, then why hasn't an enterprising businessman entered the market to attract these customers at a lower interest rate? After all, according to our legislators, a smart businessman could still make a profit. And since no one willingly pays high interest rates, current borrowers would flock to this lower-priced lender. The answer is no lender could survive at these low rates because of their expensive overhead costs and the high default rates on these loans.

On the borrowers' side, lower-priced loans do not seem to be important. Numerous surveys show that payday borrowers care more about convenience than the price of the loan. In short, as with every other economic purchase, people who take payday loans see the costs as being worth the benefits.

The common retort is that these lenders "trap" people into unmanageable debt. It is certainly true that many people take out multiple payday loans over the course of the year. When economists analyze why people do this, however, they find that the borrowers' underlying financial situation leads them into this behavior. It is not payday loans causing their financial problems. Instead, their financial problems lead them to seek payday loans. If legislation eliminates payday loans it will not eliminate the underlying financial problems of borrowers. The attacks on payday lending do not bear up under scrutiny. Instead of wasting time on this issue, legislators should focus on the real financial problems facing Ohio. These problems do not come from payday lenders - they come from the high taxes and high government spending that is dragging down the state economy. If they truly want to help financially strapped Ohioans, the state's outdated tax code is a much better target than a few businessman offering short-term loans.

Marc Kilmer is a policy analyst with the Buckeye Institute for Public Policy Solutions located in Columbus.