Are Payday Lenders Legitimate? (2008 Mar)


by Barry A. Liebling

What do pharmaceutical companies, oil companies, and Payday Lenders have in common? They are all targets of angry politicians, activists, and journalists who accuse them of working against the “public interest.” How do they differ? Adversaries of Payday Lenders would like to see them cease to exist.

Payday Lenders are firms that make small, short-term loans to consumers. According to the industry’s trade association, the Community Financial Services Association of America (, a typical transaction provides a customer with $100 for two weeks for a fee of $15. In order to get the loan the borrower must demonstrate that he has an income and a bank account. It is not legal for the consumer to roll-over the loan more than four times. Thus, the entire borrowing episode has a duration of at most ten weeks.

While there are thousands of people who enjoy borrowing from Payday Lenders, industry antagonists are not impressed. Critics have two basic problems. First, they regard the Payday Lender product as inherently a bad deal for the customer.

In a recent editorial for The Wall Street Journal, “Beyond Payday Loans”(January 24, 2008: Page A17), former President Clinton and Governor Schwartzenegger of California call for government and private interests to steer consumers away from Payday Lenders and towards banks and credit unions. The authors regard Payday Lender fees as money foolishly spent.

The most common complaint is that the annual interest rate is exorbitantly high – far in excess of what the rate would be on a bank loan, a mortgage, or a credit card. CFSA counters that Payday Lender fees are for some consumers less expensive than alternatives such as charges for bounced checks or paying late fees on utility bills or credit cards.

And there is more to evaluating the quality of the deal than the fees. Many consumers find that borrowing from a Payday Lender is easier than negotiating credit with a bank or pleading with friends and relatives. They value the saved time and effort for getting money quickly. Furthermore, some are attracted to the fact that they cannot roll-over the Payday Lender debt for more than ten weeks which limits how long their debt will last – a benefit that banks and credit unions do not provide.

The core issue is who should decide whether a Payday Lender is offering a good or bad deal. Critics believe that they have the right and the wisdom to overrule customers’ preferences. This stands in opposition to an essential condition for being a free individual – sovereignty over your own life which includes the authority to decide for yourself which financial services to seek.

The second problem critics have with Payday Lenders is more serious. The charge is that customers are being exploited because they do not understand the terms of the deal.

There are certainly cases where the customer does not grasp what he is getting into because the Payday Lender is deliberately being deceptive. If a Payday Lender, or any person in business, attempts to use fraud as a tactic there is little to say. All fraud is wrong, contemptible, and ought to be punished by law.

The more interesting case is where the Payday Lender is honest and forthright, but the customer still fails to understand the essentials of the contract. A partial solution is to communicate with potential customers with fastidious clarity – clearly spelling out the conditions of the loan. This minimizes but does not eliminate misunderstanding. Reasonable consumers will get it – but there will always be those who either refuse to understand or are not competent to interpret the contract.

The Wall Street Journal

recently published an article by Ellen E. Schultz and Theo Francis (Social Insecurity: High-Interest Lenders Tap Elderly, Disabled. by Ellen E. Schultz and Theo Francis. The Wall Street Journal. February 12, 2008. Page A1) that described two cases where Payday Lenders had customers who did not comprehend what they were doing. In one case an elderly man who cannot read and is not sure of his age borrowed money and is bewildered about how to extricate himself from debt. Another instance cited was a single mother of three who “owes more than $5,000 on loans from almost a dozen lenders.” The authors suggest she is confused, unaware of how she got into her predicament, and puzzled about what to do next.

A responsible Payday Lender, like any business professional, would have no desire to do business with someone who does not comprehend the implications of the contract. Dealing by mutual consent implies that both parties are making an informed decision.

What actions – independent of government mandates – might a Payday Lender take to filter out would-be borrowers who lack the skills to evaluate the terms of a loan? One possibility is to require applicants to state, in their own words, their understanding of what they are supposed to do in return for the money they borrow. This exercise could alert both the customer and the company when something is wrong and the transaction should not proceed. A recording of the statement could be part of a company’s documentation that demonstrates its adherence to best practices.

A Payday Lender will benefit to the extent that it demonstrates that its customers freely choose its services and have an accurate understanding of what they are getting into. While intractable critics will not be mollified, fair-minded observers will see that offering small, short-term loans can be valuable.

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