Predatory payday lending: today's debt slavery
Part One: Discover
by Michael Gerson
[The following is an excerpt from an upcoming book on opportunity.]
In the debate over poverty in America, there is a serious disagreement about how best to increase the rewards of work and encourage economic mobility.
Yet whatever one’s view, no one in this policy debate would contend that businesses and government should take more money from the poor by deceptive and exploitative means.
That, however, is exactly what is happening under the radar across the country. As we engage in a largely theoretical debate about the causes and cures of poverty, the poor are being cheated out of billions of dollars by an unholy alliance of business and government known as the payday loan industry.
If you live in one of the 36 states that allow payday loans, you have probably seen the storefronts in low-income neighborhoods and near military bases and nursing homes. These businesses offer short-term loans without credit checks. A typical two-week payday loan has an annualized interest rate of between 400 and 500 percent. The median income of payday borrowers is about $22,000 a year – below the poverty line for a family of four.
Advertisements for payday loans emphasize temporary help in cash flow emergencies. But that is not the real business model at work here. More than 70 percent of first loans cover ordinary living expenses – rent, utility, and credit card bills. And lenders make their profits on repeat borrowers who are forced to roll over loans and spend much of the year in debt. About 75 percent of fees collected by payday lenders come from borrowers who take out more than 11 loans a year. “The theory of the business,” according to one payday loan executive, “is [that] you’ve got to get that customer in, work to turn him into a repetitive, long-term customer, because that’s really where the profitability is.”
The result is often a debt spiral in which the poor live loan to loan until their financial lives are destroyed. According to one study, those who routinely take out payday loans are less likely to make their child support payments, more likely to rely on food stamps and more likely to enter bankruptcy. Owed money is sometimes seized directly from bank accounts by lenders. Failure to make payments can bring lawsuits.
Payday loans are a $46 billion a year industry that targets the poor and makes profits by encouraging debt dependence. One just lending advocate calls such loans an “intentionally defective financial product that is deliberately marketed to the unsophisticated.”
This type of predatory business practice requires government regulation. But this has not been easy in many states, given that payday lenders are often major political campaign contributors. Still, state governments have attempted a variety of reforms: setting a maximum allowable interest charge, limiting the number of payday loans a person may take out each year, and limiting payments to an affordable percentage of a borrower’s income. Behind these measures is a basic principle: It is wrong to make loans without making sure a borrower can afford to repay them. The indiscriminate offer of credit is really the encouragement of debt servitude. And businesses that depend for their profits on the abuse of debt are abusing their customers and degrading their dignity.
While payday loans themselves are often destructive, the demand for payday loans tells us something. There is a genuine need for short-term credit in poor communities, where many people have no credit rating and limited experience with the banking system. This is a gap that credit unions and nonprofits should be encouraged to fill.
Government should make it easier for churches and community groups to make small, no-interest loans without heavy regulations. And nonprofits should encourage the creation of lending circles, in which members pay monthly into a common fund, which they can borrow against for emergencies, or, say, to create a small business. (This model has been dramatically successful across the developing world.) Limiting payday loans should be accompanied by the provision of sources of responsible credit that help address the needs of borrowers without exploitation.
Predatory payday lending amounts to the systematic targeting of the poor for profit and revenue. It also represents a dividing line in political philosophy. Payday lending is often defended by appealing to rights: to economic rights (particularly the right of businesses to charge interest at any rate without determining an ability to repay) and to individual rights (particularly the right of a person to take out a loan). But both of these conceptions of rights end up being the ability for the strong to exploit the vulnerable. And any view of government committed to public justice will reject that.