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Ever been in a tight financial squeeze? Couldn't pay a bill, or needed something—gas, groceries, medicine—that you just couldn't afford? It's a common enough experience; the last U.S. Census reported that over the course of a year, 9.9 percent of the population was unable to pay a utility bill on at least one occasion. Most people, when faced with this predicament, opt to use a credit card or borrow money from a family member.
But not everyone has these options. And for those who don't – but who still need flexibility in their finances – payday advance services, despite their reputation, can be a help and a reassurance. Yet a proposed state law capping interest rates, and thus forcing payday advance services out of business -- would put Virginia in the ranks of states that have chosen to remove that option, and in doing so would most harm those whom the law intends to help.
That's because of these advances go to people with lower incomes who have nowhere else to turn. The majority of payday loans go to borrowers making less than $50,000 a year who have poor credit. Typical loans run about $300 and last for a period of about two weeks – in other words, small loans designed to fill in the cracks and pay for the necessities. Short-term loans might not be a perfect solution, but they can provide genuine help in tough times.
Of course, that's not how the story is typically told. Most of the time, payday advance services are portrayed as a social blight. But that's exactly wrong, and represents a sadly uninformed view of how real-world finances often work. Critics throw around scary numbers like 390% APR, but a $15 fee on a two week, $100 loan is a small price to pay for convenient access to money to pay for heating or groceries. For those with tight finances, simply knowing that the option exists is bound to be a stress reliever. This cannot legitimately be called "predatory lending."
And indeed, a recent study by Donald Morgan of the Federal Reserve Bank of New York reported that payday lenders do not qualify as "predatory," In fact, strong evidence shows that their presence tends to increase financial security. Households in states served by payday lenders who face no restrictions are less likely to have difficulty finding credit, and are no more likely to carry a higher debt load. Additionally, households who face income flux but have unrestricted access to payday advance services are actually less likely to have missed a payment on debt during the year previous.
Thanks to services provided by payday lenders, consumer finances become more stable. But these services would be put out of business were the law's proposed 36% interest-rate cap put in place. That would put the two-week fee on a $100 loan at just $1.38, hardly enough to stay in business. Even tax-exempt, non-profit charity lenders like Goodwill charge a $10 fee on every $100 borrowed – for a total of 252% APR. If non-profits charge that much, it's clear that no business would be able to survive on the measly returns provided by the proposed interest rate cap – leaving borrowers in need of financial flexibility in the lurch.
The alternatives are even less appealing. Forcing advance lenders to shut their doors won't suddenly cure the financial woes of many low-income families. Closing down one option will result in many turning to others. And what does that leave? Bounced checks? Unpaid bills? Loan sharks? Credit exists to help people add a measure of flexibility to their personal finances. Naturally, people with poor credit will pay more for this convenience, but it can only harm them to deny it entirely.
And if they are forced to resort to other measures, they will simply end up paying even higher rates than those offered by payday lenders. Bounced checks result in fees that total up to a whopping 2,795% APR. Late fees on missed bills can be similarly exorbitant. Shady loan sharks and unregulated off-shore lending, made possible by the internet, are flat-out dangerous.
Yet advocates of rate caps on loans seem determined to push borrowers toward these options anyway. No doubt, they have good intentions in mind, but good intentions alone won't help anyone pay for food, water, or electricity. High interest rates may not always be the most appealing choice, but for those in a financial bind, they're a small price to pay for peace of mind.