Payday loans have a bad rap.
With triple-digit annual percentage rates and exceedingly abbreviated terms (the full value of the loan is typically drafted from a borrower's bank account immediately following payroll deposit), hapless consumer-debtors often find themselves stuck in an endless cycle of costly renewals that amount to death by a thousand cuts.
A handful of states and the Consumer Financial Protection Bureau are attempting to tackle these problems by enacting laws and devising regulations that limit interest rates, fees and the number of successive loan rollovers—and even requiring some honest-to-goodness credit underwriting (a paystub is normally all that's needed to qualify for these loans). No doubt a good portion of the 12 million consumers who rely on this method of financing worry that doing so will limit its availability.
The fundamental problem, however, isn't so much the amount that's charged as it is how quickly the money has to be repaid.
I say that because to the typical customer—an unbanked (no depository relationship) or underbanked (no credit relationship) consumer of uncertain financial literacy—parting with $50 from a $500 paycheck in exchange for $450 worth of cash-in-a-hurry isn't hard to rationalize. Also, that same upfront charge happens to represent the only way that a lender has to recover in so brief a period the costs it incurs to originate, settle and profit from loans that present a higher-than-average risk of default.
Of course, the thought of paying 10% on a loan that will be outstanding for only one week or two weeks (the simple APR equivalent for that is 520% and 260%, respectively) is repellant to those who don't share the same dire financial circumstances. But for those who haven't the choice, it would help if the repayment term was longer and remittances were made in equal periodic installments.
For example, suppose a lender charged a credit-card-comparable rate of 24% interest for a six-month loan that's designed to be repaid in 13 equal bi-weekly installments (assuming an every-other-week payroll cycle). Not only would the individual payments amount to less than 10% of the originally borrowed amount, but over the term of the loan the lender would also realize more than one and a half times the value of the fee it would otherwise have received upfront.
What's more, the greater affordability of these payments will also help diminish the risk of default and help borrowers to avoid the destructive pattern of continually rolling over their loans.
Standardizing a longer repayment term, however, isn't enough. We must also establish a national usury limit that's APR-based (annual percentage rate calculations mathematically combine interest rates and fees) to govern all types of consumer credit-related products that are offered by all types of lending institutions—banks and nonbanks, online and offline alike. That way, even consumers with limited financial literacy will be able to properly compare the costs for comparably structured transactions.
Look, left to our own devices, most of us would never consider undertaking this type of financing. But that doesn't mean we shouldn't do all we can to rehabilitate these products for the benefit of those who are compelled to make a different choice.
This story is an Op/Ed contribution to Credit.com and does not necessarily represent the views of the company or its partners.
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