Credit is necessary for financial stability in today’s economy. Consumers need access to credit in order to lease a car or establish a residency. A lack of credit creates barriers to securing a job, home, or car. Further, routine expenses vary month to month, and on occasion, even a prudent budgeter might need credit if their paycheck does not meet their current obligations.
For low-income people, the lack of access to traditional financial institutions can mean having to turn to nontraditional lenders to meet their financial needs. When faced with losing electricity, eviction, or being late on bill payments, some are tempted by easily accessible payday loans and cash advances. Industry representatives claim that payday loans help provide a necessary access to credit that low-income borrowers generally lack. A growing body of research, however, tells a different story.
Payday lenders generally lend to economically vulnerable populations, such as immigrants, young adults, ethnic minorities, and military families according to a recent study from Dr. Kurban at Howard University. As Dr. Kurban explains in his paper, The Demographics of Payday Lending in Oklahoma:
Payday lenders target certain population groups who are vulnerable because they either do not have access to regular banking services or they are misinformed about the terms and conditions of payday loans (Graves and Peterson, 2005). We determine whether census tracts with payday lenders differ from those without payday lenders based on income and demographic factors.
What he discovered was that these businesses set up shop around neighborhoods that match their target demographic, the working-poor – those who have a job and stable income, yet sometimes lack sufficient funds to handle all their expenses. Lenders leverage their position as the easiest means of obtaining a loan to charge those with no better option rates far exceeding other financial instruments. Short-term loans charge rates that far exceed what most customers can reasonably pay within the pay period, with the average APR of 350 percent in Oklahoma.
Often these loans trap consumers in a cycle of needing another loan to pay off their previous loan fees, with the average borrower being in debt for 5 months of the year, according to a Pew Report entitled ‘Payday Lending in America: Who Borrows, Where They Borrow, and Why.’
Despite Oklahoma law prohibiting renewals on payday loans, borrowers can take out concurrent loans to avoid the prohibition. In fact, The Center for Responsible Lending (CRL) found 76 percent of the national payday loan volume was ‘churned’ loans – where multiple transactions occur in the same billing cycle, meaning that the borrowers took an additional loan before paying off their current loan. Such practices promote financial instability and hurt those who can least afford it.
If short-term loans are to assist rather than exploit the borrower, the lenders must charge interests rates that the borrower can be reasonably expected to pay in the given period. Pew research found that the most important factor in determining the cost of a short-term loan is the regulation of short-term loans in that state. Some states have set an annual interest rate cap at 36 percent and established a minimum pay period of one month. Such policies reduce the risk of getting involved in a debt trap, and promote financial stability among lower-income populations. Oklahoma law mandates that borrowers must have a pay period between 12-45 days, that no individual loan exceed $500 excluding fees, and limits only the interest to $65 on a $500 loan.
Some argue that increasing restrictions on payday lenders will negatively impact low-income borrowers by eliminating their only option. Pew, however, also found that in states that prohibit storefront borrowing, only 5 out of 100 would-be-borrowers choose to borrow through another short-term lender. This suggests that the ease of access to storefronts across low-income neighborhoods and around military bases leads to a noteworthy increase in consumers deciding to borrow from a payday lender.
The high demand for payday loans signals that low income consumers are hungry for credit not offered through other lenders. The problem of predatory lending starts with the fact that credit access is almost a prerequisite to economic self-sufficiency, but sometimes the best credit instrument accessible to a low income borrowers is a payday loan. Restricting payday lenders’ ability to extract wealth from the economically vulnerable is important, but it does not address the larger problem of credit scarcity among low-income populations.
Interested in payday lending in Oklahoma? Join Oklahoma Assets Network for “Who Pays More? A Town Hall Forum on Predatory Lending in Oklahoma” on April 15th at 6:30pm at the OU Faculty House.