Payday Lending

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or a car loan to become delinquent on because of a payday loan, and therefore negatively affect their credit score. However, using credit scores is useful because they account for small infractions on credit, such as one or two delinquent payments, and not just big infractions such as foreclosure and bankruptcy (Bhutta, 2013). Those with poor credit scores would be unable to take out traditional loans such as mortgages, car loans, and obtain new credit cards; this proves that there would be a correlation between low or nonexistent credit scores and the demand for payday loans.

When a consumer is approved for a payday loan they must provide the lender with a cheque for the loan amount, plus fees and interest. Interest rates can be anywhere between 15-30% of the loan amount for every two weeks borrowed; depending on the loan terms, the interest rates can add up to be an effective annual rate of up to 400% (Caskey, 2005). Essentially, if the borrower’s repayment cheque bounces because of insufficient funds due to a difficult financial situation, their loan will very quickly become a large debt, especially if their financial situation does not change. The loan process within the payday lending market would lead the borrower into the exact financial difficulties that Bhutta’s results predict.

Despite the general population and several state governments’ beliefs that payday loans are an evil of society because of their high interest rates and fees, Bhutta’s research argues that this is not necessarily the case. Findings show that there are no significant results proving that borrowing a payday loan will adversely affect the borrower’s financial situation or credit score. The payday lending industry claims to be a source of emergency funds for people who find themselves with an expense that they are not liquid enough to cover. Although payday-lending stores are more than likely in business to turn a quick profit and not to benefit the greater good of society, Bhutta finds that is what seems to be exactly what payday lending does. It keeps borrowers afloat when they find themselves in a sticky situation, thus avoiding a worse financial fate such as bankruptcy or foreclosure. From the perspective of the borrower, high fees and interest rates are the lesser of two evils when in that situation.

Michael Stegman focuses a section of his paper entitled ‘Simple fix or nuclear option?’ on the debate of whether or not payday lending should be seen as the be-all end-all, or just a quick fix for temporary situations such as car repairs or unexpected medical fees, like Bhutta initially suggested. One of the major consequences of payday loans is that borrowers tend to extend their loans further beyond the payback date. This trend follows the increase of consumerism in North America in particular. People with credit card debt delve further into debt when they don’t realize how deep into debt they actually are. Similar situations arise with payday loans because of the ease with which borrowers can extend their loans. The lack of regulation within the payday lending market shields borrowers from the dire consequences; not knowing how much they really owe because of muddled records kept by payday loan stores gives sanction to the borrower to extend their loan agreements. This practice is similar to credit card companies, which only enforce a minimum repayment for the balance of the debt owed (Melzer, 2011). Financial debt is one of America’s biggest epidemics, and as can be seen by the articles mentioned thus far, payday lending is a major contributor to North American debt as a whole.

A big source of default on payday loans are the miscalculations done by borrowers; underestimating the domino effect renewing their loan could have on the overall interest owed leads to future financial troubles (Bhutta, 2013). Bhutta also speculates that since credit scores reflect a borrower’s ability to manage financial responsibilities, that those with high scores are responsible with their money and will therefore be responsible with their loan, and those with lower scores will most likely repeat their delinquent behaviours.

Those who borrow on their future money have, in general, lower average debt than the general population, fewer credit cards, and a lower amount of allotted credit, which coincides with borrowers being generally responsible with their finances (Bhutta, 2013). Characteristics of those who borrow are generally younger people who try to but are unable to obtain other, more mainstream forms of credit, with an average of five applications for credit just prior to turning to a payday loan. More specifically, borrowers tend to be young women, which can be interpreted as young, single mothers trying to keep their family afloat.

Overall, payday loans cannot be classified as being either good or bad for someone’s personal financial health, but directly dependent on the borrower. In a financially stable recipient who is only using the loan for its supposed intended use of smoothing out a financial rough patch or as emergency funds, there will be no impact on their overall financial health as they will most likely be able to repay the loan in the specified time. Conversely, a borrower who is considered to be financially irresponsible or for whatever reasons might be delinquent on payments, will be more likely to have a hard time repaying the loan and having it grow to be a debt of its own. Although credit scores can be affected by payday loans, it is fair to say after processing various research conducted that these loans will most likely, if at all, make a low score fall further, and have no effect on a high score.

Academic articles, such as those of Bhutta, Caskey and Stegman, present conflicting results on whether or not payday lending is ethical and moral; the results of research into the payday lending market are purely situational. Census data and credit scores cannot predict how diligent a borrower will be with repaying a payday loan. Credit scores can be indicators, and obviously being within proximity of a lending store will increase the probability of using its services, but there is no significant data that will predict how a payday loan will affect the recipient. Fees and interest levels at a particular store can even affect repayment ability of the clients. Overall, it comes down to whether the borrower understands the terms that they are agreeing to, and how bad their financial rough patch is.

References

Bhutta, Neil. 2013. “Payday Loans and Consumer Financial Health.” Finance and Economics Discussion Series Divisions of Research & Statistics and Monetary Affairs. Federal Reserve Board. Washington, D.C

Bhutta, Neil, Paige Marta Skiba and Jeremy Tobacman. 2012. “Payday Loan