Restricting Credit for Poor People
I’m sure that “restricting credit for poor people” is not the phrase supporters of capping interest rates on short-term loans would use to describe their proposed policy, but that is the effect it will have if enacted. State Rep. Mary Still (D-Columbia) will try again this year to limit interest rates on loans of $500 or less at 36 percent, and prevent borrowers from renewing their loans. No one is likely to argue that payday loans are an attractive option, but when a person has no other options to turn to, they still beat a loan shark.
Show-Me Institute authors have previously written a few blog entries and op-eds pointing out that, for the vast majority of borrowers, payday lending is a useful service in a tough time. As Katherine Mangu-Ward argued in an indispensable discussion of the industry in Reason magazine:
As horrifying as 400 percent annual interest sounds, it doesn’t reflect the experience of the typical borrower. No one keeps a payday loan for a year; that’s not how these things function. Payday lenders charge about $15 per $100 on a seven- or 14-day loan, plus another $20 or so in fees. They check your paperwork and then give you $100 in cash. You leave a post-dated personal check as insurance and promise to come back in two weeks with $135. If you show up empty-handed, or not at all, they cash your check. If the check bounces, the firm sends debt collectors after you—not the knee-breaking kind, but the same guys who interrupt your dinner when you miss a couple of credit card payments. If you miss your deadline to repay, the lender refuses to deal with you again. Nine out of 10 customers pay on time. […]
What happens when a rate cap is imposed statewide? Dartmouth economist Jonathan Zinman looked at the payday lending industry in Oregon, where in 2007 an effective cap of $10 per $100 borrowed was imposed along with a minimum borrowing term of 31 days. (In neighboring Washington, by contrast, the standard is $15 per $100 and there is no minimum term.) Oregon’s Consumer and Business Services Department reported 346 licensed payday lending outlets at the end of 2006, six months before the cap kicked in. Seven months after the cap took effect, that number had fallen to 105. In September 2008 it was 82. In a December 2008 working paper, Zinman concluded that former payday customers in Oregon ended up using less desirable alternatives such as overdrafts and utility shutdowns, and that “restricting access caused deterioration in the overall financial condition of the Oregon households.” In summary, “restricting access to expensive credit harms consumers.”
A February 2008 study for the Federal Reserve Bank of New York found similar results: “Compared with households in states where payday lending is permitted, households in Georgia [after a May 2004 ban on payday lending] have 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,” wrote Federal Reserve research economists Donald P. Morgan and Michael R. Strain. In North Carolina, where payday loans were banned in December 2005, “households have fared about the same. This negative correlation—reduced payday credit supply, increased credit problems contradicts the debt trap critique of payday lending, but is consistent with the hypothesis that payday credit is preferable to substitutes such as the bounced-check ‘protection’ sold by credit unions and banks or loans from pawnshops.”
Two weeks before I got my loan, new restrictions took effect in Virginia, including a rate cap of 36 percent. As predicted, payday lending chains are now fleeing the commonwealth. Check ’n Go stopped originating loans in Virginia and will soon close its 68 storefronts and fire its 100 employees. The State Corporation Commission counted 630 payday lending stores in April, down from 786 in December.
As well intentioned as I’m sure Still is, Virginia’s experience shows that a 36-percent ceiling on interest rates will force lenders to shut down and consumers to turn to even costlier alternatives.