Four Myths of the Payday Loan Industry

Posted by on Jun 8, 2013 in Blog | 0 comments

 XtraCash is a provider of payday loan solutions for credit unions. We’re very concerned about the misinformation propagated by The National Consumer Law Center and the Center for Responsible Lending (CRL) regarding payday loans.  Scholarly researches by leading universities dispel this misinformation which we call the 4 myths of the payday loan industry.

Myth 1: A payday loan traps the consumer into a cycle of debt.

Research shows that the interest rates of payday loans are not the source of such debts. Marc Anthony Fusaro of Arkansas Tech University and Patricia J. Cirillo of Cypress Research Group, wrote a report, “Do Payday Loans Trap Consumers in a Cycle of Debt.” For that report, they created a field experiment where they monitored two groups – borrowers with interest-free initial payday loans and borrowers with loans carrying conventional interest rates. They chose 15 data collection cities with sufficient diversity in geography and strictness of state regulation.

The analysis revealed that high interest rates doesn’t drive high re-borrowing rates. The term “cycle of debt” is rarely used to refer to a consumer who incurs conventional credit card debt and pays the minimum monthly payment for a year before paying off the loan. However, a payday loan borrower who rolled the loan over for a year would be considered in a “cycle of debt.” The only distinction is the level of interest rate paid between the credit card debtor and payday loan borrower.

No evidence shows that a lower level of interest leads to less borrowing. The authors note that the results of their field experiments are “strong evidence that high interest rates applicable to payday loans do not drive a ‘cycle of debt.’”

Myth 2: Payday lenders are predatory, unregulated, unscrupulous companies that take advantage of financially vulnerable consumers.

The average payday loan borrower needs cash to keep the lights on, pay for an unexpected car repair, prescription medicines or emergency medical visit. The payday loan borrower isn’t using the funds for frivolous purposes. Instead, a payday loan is their emergency fund. Most of the borrowers are working single mothers with some college education living in lower-income or middle-class neighborhoods.

Payday lenders in highly regulated states such as Florida are not allowed to offer a loan to a customer who has an outstanding loan. When a borrower applies for a loan at a payday lender’s store, the lender pulls up a statewide database to see if the borrower has any other outstanding loans. If they have another payday loan that hasn’t been paid off, the borrower is denied another loan. Florida’s regulations are a model for other states seeking to regulate payday lenders.

In states that ban payday loans such as Georgia and North Carolina, researchers found that consumers bounced more checks, filed more complaints against lenders and debt collectors and went bankrupt more often. Since the typical payday loan borrower is a high-risk borrower, traditional loan sources are unavailable. Shutting down access to alternative loan options puts that borrower at risk for incurring overdraft protection fees that have a significantly higher APR compared to a payday loan.

Myth 3: Payday loans APR are sky high compared to short term loan products and other loan alternatives.

The cost of payday loans is admittedly higher than 18% or 28% APR. However, the APR is considerably lower than the APR generated by fees from bounced checks, non sufficient funds or late payment charges. An example is that a $22 fee on a $100 courtesy pay (3 day term) = 2,677% APR. Or a $48 NSF and Merchant Fee on a $100 NSF check is 1251% APR. How about a $50 late fee or reconnect fee on a $100 utility bill which is 1251% APR. Compared to these options, a payday loan is an attractive financial solution for a short-term problem.

Myth 4: Consumers who use payday loans are prone to file bankruptcy.

No relationship exists between payday lending and personal bankruptcy filings according to Petru S. Stoianovici of the Battle Group and Michael T. Maloney, PH.D. Of Clemson University’s report, “Restriction on Credit: A Public Policy Analysis of Payday Lending.” They used data from 2000 to 2006 to investigate the connection between payday lending and personal bankruptcy filings and found “no empirical evidence that payday lending leads to more bankruptcy filings.”

The study further revealed, “If anything, the presence of payday stores in a state is associated with a smaller number of chapter 7 bankruptcy filings.” And the presence of payday stores “does not seem to have any significant effect on chapter 13 and total personal bankruptcy filings.” Obviously a payday loan consumer isn’t setting themselves up for bankruptcy in the future. Instead, the loan is a short-term solution to keep the lights on, keep the car running so they can get to work or to pay for an emergency doctor visit or medication.”

In closing, the myths promulgated by the National Consumer Law Center and the Center for Responsible Lending (CRL) hurt the consumer and CUSOs seeking to offer loan alternatives to their customers who don’t qualify for traditional short-term loan products. We ask for a fair, open, frank discussion on payday loan practices before casting the whole industry as unscrupulous, abusive and predatory. We believe that the erroneous information is an example of unscrupulous abusive use of the facts by predatory media seeking to sensationalize half-truths at the expense of consumers and CUSOs.

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