Everyone loves the party game/icebreaker “two truths and a lie.”
Can you identify which of the following is NOT true about short-term, high-interest loans?
A. Banning short-term loans, often called payday loans, will benefit poor people who are exploited by these lenders.
B. A pay day loan is sometimes the appropriate choice for some borrowers.
C. A short-term loan can bail a conscientious borrower out of a jam set her on a path to a better financial future.
Well-intended people, nonprofits, and legislators have long wanted to find a way to eliminate the short-term, high-interest loans known as payday loans.
Many short-term borrowers, however, would be seriously harmed by the loss of this resource.
In 2008 a New York Federal Reserve study compared how households managed in two states that allow payday loans and two that don’t. The Wall Street Journal explained what the study found:
Compared with households in states where payday lending is allowed, the study found that Georgia and North Carolina households had “bounced more checks, complained more to the Federal Trade Commission about lenders and debt collectors, and filed for Chapter 7 bankruptcy protection at a higher rate.”
The researchers concluded that payday credit is preferable to alternatives such as bounced-check protection from banks or loans from pawnshops.
While nobody should ever take out a high-interest loan when better rates are available, the payday loan can be a life saver for consumers who can’t obtain traditional credit. People without credit or bank accounts can receive such a loan to meet an emergency almost immediately, if they demonstrate that they have the ability to pay it back (usually by presenting paycheck stubs).
Contrary of the image their “betters” have of payday loan clients rushing headlong into a high-interest loan, many borrowers carefully weigh their alternatives. In 2009, a study by George Washington University found, according to the Wall Street Journal, that “about half of borrowers surveyed had considered other credit alternatives, and more than 80% lacked funds in their bank accounts to cover expenses. Payday loans can prevent borrowers from incurring more expensive overdraft fees.”
An IWF Policy Focus on financial services for the unbanked showed that, without the availability of these loans, some users could find themselves facing life-altering collateral consequences (such as eviction).
Conscientious consumers of short-term loans are capable of using this resource wisely.
Robert Sherrill, now a successful businessman, who grew up in public housing and spent time in prison, is a case in point. His book, The Journey Back, describes how he transformed himself into an upstanding citizen, in part by the wise use of a short-term loan.
As Sherrill recounted in an article in the D.C. Examiner:
As many small business owners will tell you, starting a company isn’t easy — there never seems to be enough money. I needed a simple $1,000 loan to get myself up and running; but I quickly found out that banks and credit unions have regulations and rules that typically hinder those with a criminal background and a turbulent financial history. …
I had two choices: Return to my old ways and earn money on the streets, or try for a personal loan to keep my business afloat.
Sherrill recalled that a financial service center “took a chance” on him. The loan saved his business and let him move forward. He now employs more than 20 people.
Yes, there are people who abuse these loans (as there are people who abuse more “respectable” forms of credit). But there are also people like Robert Sherrill. We need to allow people to make their own choices, as Robert Sherrill did.