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Payday loans are an expensive choice
Politicians in many states are upset with the proliferation of payday loan shops, which charge high interest rates and prey on vulnerable citizens. A study shows that banks could offer similar but less expensive products. Will they?
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Payday loans could be offset by new banking products. Will the banks offer them?
Payday loans are becoming a problem in more and more communities, and legislators are trying to find solutions. These businesses specialize in small, short-term loans, typically less than $500. The fees they charge vary, but are usually in the range of $15 for every $100 borrowed, payable in two weeks’ time. If someone wants to borrow $100, they write a check for $115, and two weeks later, they either pay it back or the loan company cashes the check. That may seem like a fairly small amount to charge, but many customers of these businesses find themselves using them as a last resort and are often unable to repay them. Once that happens, the interest piles up. And 15%, every two weeks, amounts to 390% per year, a far higher rate than can be had through most other types of loans. In fact, the interest rates charged by many credit card companies, which can run in the 25% range, seems quite reasonable in comparison.
Payday loans are looked upon with disapproval by legislators because the lenders prey upon the poor in society, who often don’t have access to other lending choices, such as home equity loans or credit cards. With no credit report on such people, other loans simply aren’t possible. Many states have enacted tough lending laws designed to regulate these businesses, but they often circumvent these laws by working with banks in other states which have more lenient lending laws.
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A recent study suggests that banks could offer reasonable alternatives in the form of short term loans at more reasonable rates. In fact, Citibank is offering a combined line of credit and checking account, with rates in the 17% range. This would seem to be a nice alternative to lending at 390%, but many banks are reluctant to offer such loans because they conflict with other existing bank products that are more profitable. Most banks realize a sizable portion of their products through their overdraft protection. Overdraft protection is a system that allows customers to write checks for more money than they have in their accounts, without worry that the checks will be returned for insufficient funds. Instead, the bank pays the the check, and withdraws the overdrawn amount, plus a fee for the service, from the customer’s account at a later date. That fee, which typically runs about $30, applies to any overdrawn amount. If a customer writes a check for $1 more than he or she has in their account, the $30 fee applies, making overdraft protection a very profitable product for the banks that offer it.
When you can charge $30 for a $1 loan, with an effective 3000% interest rate, you are suddenly less interested in offering money at 17%.
As more and more legislatures become successful at regulating these businesses, some banks will enter the short term, small loan business. It will just take time.
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