The Flip Side of Payday Lending

• Email
• Share
• Print

A few months ago, I wrote about how the government is trying to protect those in the military from payday lenders, and I suggested that we might all benefit from such protection. For those not in the know, companies like Advance America (NYSE: AEA), Dollar Financial (Nasdaq: DLLR), Cash America (NYSE: CSH), and EZCORP (Nasdaq: EZPW) offer short-term loans with steep fees -- fees that are equivalent to annual percentage rates of 200% to 400% or more.

I heard from a bunch of folks, though, after that article -- and many made good points in favor of the industry. Permit me to share some:

• David, a reader from Georgia, opined, "These are legitimate companies that provide a service that was previously provided by most of the underworld and at least they are some what regulated." That's fair enough -- for those who can't borrow elsewhere, at least this option exists.

• Another reader asked, along similar lines, "If payday loans are so bad... then where do you recommend those... people go to get a loan? Will Bank of America (NYSE: BAC) loan them $100 or $200?... until there is an alternative, many typical people have only a few choices to get a loan and make ends meet." True, true. I don't see Citigroup (NYSE: C) or Wells Fargo (NYSE: WFC) offering these loans. Perhaps if they could figure out a way to do so profitably, it would be a win-win solution.

• Steve noted: "There is a reason people are being charged the rate they are in a competitive environment, and it's not because of malice or spite. You aren't stamped with a 400 FICO score; you earn it." This is also true. Often those who use payday lenders have few alternatives because of their poor credit ratings. While low scores sometimes happen to responsible people who are suddenly faced with major medical expenses or a lost job or a deadbeat co-signer, they're also often carried by people who charged more than they could afford and didn't pay their bills on time. These are not the best bets for lenders. Steve added: "'Protecting' servicemen from payday lenders means sending them to a different type of lender -- the ham-fisted type with a crooked nose and unpleasant demeanor."

• Mark asked, "What justification is there for price controls in the lending of money? If any lender figures out a way to profitably lend $500 for two weeks at a lower cost, he will do so and own the market." He also noted that competition is making loans more affordable: "Returns to payday lenders are decreasing as the industry becomes more competitive. Five years ago, payday lenders made much more per loan than they do today."

The flip side
These are all good points. They reminded me of a similar kind of lending that I strongly believe in: microcredit. Microcredit is the concept behind some remarkable charitable organizations (and businesses) that lend tiny amounts (often $100 or $200) to the world's poor at interest rates that are often higher than we in the middle class of the developed world would think are steep. (I wrote about the origin of microcredit in this article.) In places like Bangladesh (and let's face it -- in America, too), many poor people simply have no other safe alternative than borrowing at somewhat steep rates. But if they're responsible borrowers and pay back their loans, these loans can transform their lives.

We have supported microcredit organizations in the past through our annual Foolanthropy drives. Learn about this year's campaign, which is devoted entirely to bringing financial literacy to youth, and consider chipping in a few dollars with us, please.

But back to payday lending and the cap in rates for the military. My colleague Rich Duprey recently weighed in against the move, rebutting my original article very thoughtfully. He concurred with several of the points my readers made, noting that major banks have abandoned payday loan customers and that, although payday loan fees are higher, they're the only solution for some borrowers.

Good news
The fact that the industry is getting more competitive -- after all, there aren't massive barriers to entry, as all you need is money to loan -- is one good sign for borrowers. Here's another: The payday lending industry has recently decided to be more upfront with customers. According to a press release, the Community Financial Services Association of America (CFSA) will have its member companies put up poster-sized displays explaining fees. Those members include about 60% of payday loan locations nationwide.