A law that could severely restrict the short-term loan business in the state of California is wending its way through the state legislature.
The bill is sponsored by two members of the Assembly, Tim Grayson and Monique Limon, who has touted her friendship with Richard Cordray, former director of the Consumer Financial Protection Bureau. Under Cordray, the CFPB waged war on short-term loans.
Short-term loans are better known as payday loans, and members of the elite with bank accounts and good credit ratings tend to regard such loans as beyond the pale. They believe halting these loans would beneficial. This bill would put a lot of these loan outlets out of business.
Most short-term loans are for several hundred dollars. But some borrowers get larger loans. The bill would cap interest rates for loans of $2,500 and above at 36 percent. It would also stipulate a minimum term of 12 months to repay the loan.
Some short-term lenders, who already are taking a chance on borrowers with poor credit and few assets, simply could not afford to stay in business if this bill becomes law. That would be just fine with foes of short-term loans.
But this kind of paternalism towards short-term borrowers is misguided and can put many of them in a bind. Nobody wants to take out a high-interest loan. However, as my colleague Patrice pointed out, sometimes it is the logical choice. Patrice wrote:
Poor and working-class Americans know what their other options are and are smart enough to do the math for themselves. They know that in many cases these loans, even with high interest rates, are cheaper than incurring daily fees for overdrawing their accounts.
Overdraft fees are a reason many people avoid banks altogether and seek alternative cash sources to cover a bill or an unexpected expense. Overdraft fees hit a record high average of $33.38 in 2017, up from $21.57 in 1998. In total, Americans paid $33.3 billion last year in overdraft fees.
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When Georgia and North Carolina banned small-dollar loans, consumers bounced more checks, filed for Chapter 7 bankruptcy protection at a higher rate, and complained more to the Federal Trade Commission about lenders and debt collectors. At a Federal Reserve center in Atlanta for example, customers paid an extra $36 million per year in bounced check fees after the ban on payday loans was implemented.
Short-term loans can work in a pinch. They should not become a way of life. Well-intentioned people want to restrict this option, without understanding that borrowers with no other source of help, can be bailed out by a short-term loan. Of course—as with any kind of loan—it is important that the borrower be responsible.
But this is a decision that should be left to the borrower, not those, however well-intended, who are not familiar with the financial needs of those who, if careful, just might get out of a tight spot with a short-term loan.