Public Servants as Policy Advocates: A Case Study of Payday Lending
By Elle Getschman, Analyst, Novi City Manager’s OfficeYou have probably seen one of the many commercials promising fast, easy cash with a payday loan, but most of us won’t ever need to utilize this type of service and put little thought into the concept. While researching state-level payday lending policy to complete my MPA, I quickly discovered just how problematic the industry can be in practice. Many people do choose to use payday loans, amounting annually to 12 million borrowers and $9 billion in loan fees.
For those who don’t know, a payday loan is a short-term, high-cost loan to be repaid on the borrower’s next payday (typically two weeks), in exchange for either a post-dated check or electronic access to a borrower’s bank account. Although you will likely hear some debate as to whether payday lending is inherently bad, the data reveal that most borrowers will end up defaulting on this type of loan.
Payday loans are problematic on a massive scale because the majority of borrowers are low-income. Low-income borrowers will use the loans for long-term use, despite industry and regulator warnings that the loans are for short-term use only. Pew Charitable Trusts found that 7 in 10 borrowers are using payday loans for recurring expenses: rent, utilities, or food, as opposed to unexpected, but necessary, one-time, emergency expenses: medical bills, or car repairs.
The structure of a payday loan often hinders repayment. Lump-sum payments to be made in two weeks, or less, are often unwieldy for low-income borrowers. A payment typically totals close to 25% or 30% of a borrower’s income, including all fees and interest. Payday lenders do not adequately assess ability to repay, which helps to make obtaining the loan quick and easy, but actually disadvantages the borrower’s repayment.
When borrowers can’t repay they are forced to renew the loan and incur an entirely new set of fees, often accompanied with higher levels of interest. The Consumer Financial Protection Bureau (CFPB) found that 4 out of 5 payday loans are rolled over or renewed within 14 days. The loans often come with triple digit annual percentage rates (APRs), which become problematic when borrowers end up paying off the loans over an extended period of time (if they are able to repay at all).
Payday lending storefronts currently operate in 36 states, including Michigan, and states are best poised to pass policies that can address the problematic nature of payday loans. States without payday lending storefronts have effectively prohibited operation by enacting strict rate caps. At the federal level, the CFPB is not allowed to regulate interest rates.
Certain states have characteristics that are strongly associated with payday lending, and should especially consider policy alternatives to reduce payday lending volumes. Through my own data collection and analysis, I determined several of the characteristics that stand out as associated with high payday lending volumes. These include more individuals living below the poverty line, higher welfare expenditures, higher underemployment, and lower median incomes. These states can begin to consider meaningful regulation of payday lending.
Meaningful regulation is a relative concept. Restricting access to payday loans seems like it would solve the problems of payday lending, but as with all policy alternatives, there are no black and white solutions. Critics will argue that payday loans are THE only credit option for low-income borrowers. However, it seems unethical to allow so many borrowers to be taken advantage of in the name of equal access to credit solutions. To meet all of the evaluative criteria, policies that prohibit payday lending should be coupled with those that provide alternative, high-quality forms of small dollar credit.
For those caught in a cycle of payday lending debt, policy provides an effective solution. Not only can it eliminate predatory payday lending practices, but it can also foster the creation of healthy alternatives that facilitate repayment and help borrowers to build credit. State policy, when carefully determined and applied in an appropriate setting, can meaningfully regulate the payday lending industry. In fact, government, at all levels, can provide answers to a myriad of other pervasive problems through policy. The process of analyzing and evaluating policy alternatives provides important support to lawmakers seeking to effectively answer these problems and is just another avenue for making a noticeable difference in the public sector.
Elle Getschman is a recent graduate of the EMU MPA Program. She currently works as an analyst for the Novi City Manager's Office and is looking forward to starting a productive career in the public sector.