Cap on payday loans would hurt those most in need

Original Article:

  • Author: David Kreutzer

  • Publication Date: January 2008

  • Newspaper: Daily Press

Right now, residents of the early presidential primary states are learning the skill known as “choosing the least bad option.” It’s a good skill to have. Many Virginians face a similar decision when choosing between interest rates that can range from 390 to 2,795 percent on their loans. And while 390 percent is not a rate anybody with a good credit rating would pay, it is the “least bad” deal many marginal borrowers can get. Unfortunately, there is movement in the Virginia General Assembly to take this best choice off the menu.

Though well-intentioned, proposed legislation capping interest rates at 36 percent per year would kill the payday lending industry in Virginia. Ironically, this removes the best option above but leaves the others.

A $100 payday loan costs $15, or 15 percent. Whether the cost is called a “fee” or “interest” doesn’t matter to the borrower. But, according to regulators it is “interest.” This means the 15 percent is multiplied by 26 to get an annual percentage rate, or APR, of 390 percent. Similar math shows the proposed 36 percent cap translates to 1.4 percent for a two-week loan.

Though the 36 percent cap might be an outrageously profitable APR for a six-year $30,000 car loan, it won’t cover the disbursement and collection costs for a two-week $100 loan. In every state that implemented this cap, the payday loan industry shut down — eliminating one choice for the cash-strapped.

What options are left? Though not considered loans, bouncing checks and paying bills late are frequently used options. Because the regulators ruled that bounced-check charges and late fees are not “interest,” these fees are exempt from the 36 percent APR cap. However, if calculated as interest (like the $15 cost of a payday loan), bounced- check fees generate APRs in excess of 2,700 percent and late fees can easily exceed an APR of 600 percent.

Good intentions are frequently the paving stones on roads to ruin. The road to financial ruin is no exception. Though the groups using their political clout to push these interest caps may think they are helping the less fortunate, they should go beyond anecdotes and read some of the research on the issue.

Recent legislation in Georgia and North Carolina killed their payday loan industries. What happened?

When compared to other states, a November 2007 study by the Federal Reserve Bank of New York found Chapter 7 bankruptcy filings and the number of costly bounced checks both rose in North Carolina and Georgia. Calculations for Georgia showed that the additional bounced check fees totaled $36 million and Chapter 7 filings went up nearly 9 percent.

A report done for the Annie E. Casey Foundation recognizes that borrowers are helped when they have more choices. The author, currently head of the Federal Deposit Insurance Corporation, notes the very high effective APRs that banks generate from bounced-check and nonsufficient-fund fees are much worse for the borrower than those on payday loans.

For a scale comparison, in total payday loans for 2003 were $40 billion while late-fee payments and nonsufficient funds bank penalties were nearly $60 billion. In fact 18 percent of bank profits come from nonsufficient fund fees.

Instead of killing the payday loan industry, the foundation report recommends encouraging traditional lenders to compete with the payday lenders. As with everything, more choices and more competition are better for the consumer.

A January 2007 study by the Federal Reserve Bank of New York confirms this last point. It found the more payday lenders there are per capita, the lower their fees become.

For centuries, the proud independence of its citizenry has kept the commonwealth of Virginia at the forefront in the fight against overbearing government. Forfeiting this role for feel-good legislation is a big step in the wrong direction — especially when the legislation harms those it’s intended to help.