Payday loans are already illegal in some states. Others tightly regulate the payday loan industry, in an effort to prevent possibly abusive practices. Many jurisdictions consider the rates too high and the fees too unreasonable for these kinds of loans.
However, regulators need to consider the consequences if all payday loans become illegal. Payday loan borrowers often have urgent problems, and need to have some place to turn.
Payday Rates and Penalties
Considered on the basis of what such a loan would actually cost if not paid off over a year, payday loan rates can run as high as 3600% percent in some areas. Such a rate should certainly be illegal.
People who take out payday loans may end up paying high penalties as well. If borrowers do not repay their loan on time or if their check bounces they may owe the lender additional fees. Banks also charge increasing amounts for returned checks. People whose payments are late will generally also incur higher interest rates.
When criminal organizations treat their clients this way, it is called loan-sharking. The underworld takes advantage of the foolish, the massively unlucky, and the fiscally unwary. Gamblers and people struggling with addiction form a large part of their clientele.
The same kinds of people get payday loans sometimes, but most legal borrowers are ordinary citizens who are suddenly caught short. Their car may need repairs so they can get to work, or a child may have a pressing medical emergency. People who live paycheck to paycheck are vulnerable.
The payday lenders mostly serve the working poor. Borrowers must usually show a recent pay stub, and write a post-dated check that the lender will hold until the client gets paid. Clients may also have to bring in banking records and identification.
The rates some of these establishments charge do seem criminal. However, if payday loans were actually illegal, borrowers would be thrown back on worse alternatives.
Legal Loan Alternatives
Pawnshops also charge high interest rates and fees. In addition, the borrower is in danger of losing treasured possessions, or even tools or equipment he or she needs to make a living.
Borrowing from friends and relatives can be relatively inexpensive. Yet because of the informal nature of such loans, and the character of some people who need them, such transactions can stress or even destroy important relationships.
Borrowing from criminals can be dangerous. Loan sharks are said to have alternative ways of collecting on unpaid loans. In addition, the naive borrower who goes to a loan shark may be turning down onto a spiral of increasing crime.
Borrowing against the house can be dangerous too, as many people have learned. It is also a relatively lengthy and exacting process. Not everyone qualifies for a home equity loan.
Banks and Credit Unions offer personal loans in some cases, but not everyone has a bank account.
One solution to payday loan problems is regulation. Payday lenders probably serve a useful purpose, but they should not be allowed to make unreasonable profits. States should (and some do) prohibit combinations of interest and penalties that add up to outsized costs for borrowers.
All borrowers should be told exactly what they are paying for their loan, and how much more they will owe if they cannot immediately pay it off. There should be severe penalties for deceptive practices, and regulators should monitor the lenders carefully, perhaps with undercover inspectors.
Many people have no idea of the implications of compound interest. Schoolchildren should be carefully taught how fast a debt can grow. A payday lender can take advantage of borrower ignorance.
Payday loans should not be illegal. They serve a useful social purpose, and help people in need. However, payday lenders require sharp oversight, by regulators who are alert to the necessity of protecting a vulnerable population.