Opinion: Don't restrict payday loans people need to survive pandemic
The COVID-19 pandemic has created unprecedented hardship for millions of families in all corners of our country. More than 16 million people were unemployed in July, countless businesses are either prohibited from operating or significantly limited in their operations due to state- and city-wide lockdown orders, and a third of people have reported a loss of income. Not only is the pandemic a public health emergency, but combined with its financial impacts it is a recipe for catastrophe.
Despite these problems facing everyday people, negotiations between the House and the president surrounding another relief package remain at a standstill. So with prospects of Washington delivering another round of stimulus checks or enhanced unemployment slim many people, particularly those with lower-incomes, are understandably concerned about being able to make ends meet.
In addition to rising concerns about paying their bills, worries about being able to access credit have also become a top-of-mind issue. And these Americans have a reason to be concerned. Consider this: Lenders have clamped down on consumer lending and banks are lowering credit limits and insisting on higher credit scores for loans they do make.
For consumers who have thin credit files or non-prime credit scores, they could be locked out of credit markets. To fill this void, some borrowers will have to turn to the short-term, small dollar loan industry, which offers credit though at a relatively high annual percentage rate (APR). While the loans may indeed carry a high APR, the vast majority of loans are paid back in a matter of weeks or months, not extended for an entire year.
In other words, using the APR as a metric is entirely meritless. This “payday” loan business can be a far more attractive way to deal with an emergency expense than bouncing a check, or finding an unregulated black market lender. Importantly, these payday lenders present a cash advance to a segment of the market that would otherwise go unserved.
In fact, according to a 2012 Pew Trusts study, 69% of people used payday loans to “cover a recurring expense, such as utilities, credit card bills, rent or mortgage payments, or food" and 16% of people "dealt with an unexpected expense, such as a car repair or emergency medical expense.” Small dollar credit products help them deal with everyday household expenses and that unforeseen emergency that can happen to anyone from any income level.
However, Washington Democrats are seriously considering ways to make it even harder for people to access these crucial short-term, small-dollar loans. Earlier this year, a House committee held a hearing on the need to impose price controls on how much interest lenders are able to charge borrowers.
And recently a senior member of the Democratic party introduced legislation to devastate the short-term lending industry by preventing collection of legal debts in excess of 36% APR. In May, House Financial Services Committee Chair Maxine Waters sought to push the Federal Reserve and Treasury to exclude small-dollar lenders from participating in the Paycheck Protection Program.
Many advocates of an interest rate cap mislead the public by pointing to loans with high attached APR — which is simply the rate of interest a borrower will pay over the course of a year due to compounding. However, using APR to evaluate short-term loans is a bad metric, since most short-term loans act as a cash advance that are paid back in full at the borrower’s next pay period.
As any individual who has taken Economics 101 knows, government-imposed price controls do not work. Virtually every example in history shows price controls worsen the very problems they are supposed to solve.
Whether placed on gasoline, banking interchange fees, or prescription drugs, setting price controls at below market rates leads to shortages, squeezes the cost bubble toward some other portion of the economy, and imposes a deadweight cost on society.
Capping rates also interferes with a lender’s ability to judge borrowers who may be creditworthy, or credit unworthy. To that end, interest rates are incredibly important for lenders, as they allow them to price in all their fixed and unforeseen costs. Factors such as the lender’s costs and risks, and consumer demand for credit all affect how expensive or inexpensive credit will be. Any short-term interest rate includes many financial factors, such as a borrower's risk of default and fixed costs of operating a business.
It’s clear that some members of Congress are more interested in trying to score political points regarding payday lending than the actual policy merits and unintended consequences of a 36% government-imposed price control. It is unfortunate that many lawmakers talk about making credit and financial services more accessible to traditionally under-banked populations are at the same time pushing disastrous policies that would severely hamper consumer markets.
Thomas Aiello is the policy and government affairs manager at National Taxpayers Union.