Myths vs. Reality of Payday Loans

The realities of payday lending are much less exciting than the myths and propaganda promoted by opponents of the payday advance industry.  To help you separate fact from fiction, the following is a straightforward and honest examination of the payday lending industry and how the payday advanceworks.

Myth: Payday loans are extremely expensive and have exorbitant interest rates.

Reality:
Payday loans are two-week loans—not annual loans! Industry critics quote the “390% annual percentage rate” to misrepresent the truth and to help make their case. The typical fee charged by payday lenders is $15 per $100 borrowed, or a simple 15 percent for a two-week duration. The only way to reach the triple digit APRs quoted by critics is to roll the two-week loan over 26 times (a full year). This is unrealistic considering that many states do not even allow one rollover. In states that do permit rollovers, CFSA members limit rollovers to four or the state limit—whichever is less.

But, even if the loan was rolled over for the entire year, the high APR of payday loans pales in comparison to the realistic alternatives considered by consumers.

How does a $100 payday loan compare?

$100 payday advance with a $15 fee = 391% APR
$100 bounced check with $54 NSF/merchant fees = 1,409% APR
$100 credit card balance with a $37 late fee = 965% APR
$100 utility bill with $46 late/reconnect fees = 1,203% APR.

Myth: Payday loans trap borrowers in a never-ending “cycle of debt”.

Reality: Although the phrase “cycle of debt” is a favorite among industry critics, it’s not based on the truth. In states that permit rollovers, CFSA members limit rollovers to four or the state limit—whichever is less. The reality is that a loan cannot be outstanding longer than eight weeks (two-week loan rolled-over four times).

Researchers and state regulators consistently report that 70-80% of customers use payday advances between once a year and about once a month. People who bounce checks and use overdraft protection often do so at a higher frequency. The fact is that a payday advance is more economical than other options.

Myth: Payday lenders take advantage of poor people and minorities.

Reality: Critics of the industry have been successfully perpetuating the myth that the payday advance industry exploits the downtrodden. By perpetuating this myth, they have created a warped idea of the industry’s customer base. Actually, payday advance customers represent the heart of America’s middle class. They are typical hard working adults who may not have savings or disposable income to use as a safety net when unexpected expenses occur.

Here are the facts:

• The majority of payday advance customers earn between $25,000 and $50,000 annually;
• Sixty-eight percent are under 45 years old; only 4 percent are over 65, compared to 20 percent of the population;
• Ninety-four percent have a high school diploma or better, with 56 percent having some college or a degree;
• Forty-two percent own their own homes;
• The majority are married and 64 percent have children in the household; and,
• One hundred percent have steady incomes and active checking accounts, both of which are required to receive a payday advance. *

*Source: The Credit Research Center, McDonough School of Business, Georgetown University, Gregory Elliehausen and Edward C. Lawrence. Payday Advance Credit in America: An Analysis of Customer Demand. April 2001.

If you find a study that concludes otherwise, chances are the researcher combined payday lenders with other financial services such as pawnbrokers, car title lenders and check cashing outlets. These entities are in a different line of business and have a different customer base. All payday advance customers have steady jobs and active bank accounts.

Myth: Payday lenders’ high fees help the industry make billions in profits.

Reality: Small denomination, short-term loans are very expensive to originate and maintain, which is why most banks no longer offer the product. According to the Federal Reserve Banks 1999 Commercial Bank National Average Report, the cost for a small bank to originate and maintain a loan for one month is $174.

Industry critics fail to recognize that, in addition to the cost of administering the loan, payday lenders incur the normal overhead costs of running a business and paying employee salaries and benefits.

A study by the FDIC Center for Financial Research found that “operating costs lie in the range of advance fees” [collected] and that, after subtracting fixed operating costs and “unusually high rate of default losses,” payday loans “may not necessarily yield extraordinary profits. ”

Myth: Payday lenders do not want to be regulated.

Reality: Quite the contrary. Our industry is currently regulated in 37 states and the District of Columbia, and CFSA is working to have all 50 states regulated. While the industry does not want to be regulated out of business (as industry critics would like), it has always supported sound and balanced regulations that protect consumers, while preserving their right to financial options.

Over the past decade, most states have created or maintained a regulatory environment that satisfies the robust consumer demand for these short-term, low denomination loans. Working with CFSA, state policy makers have balanced the interests of the industry with substantive consumer protections that ensure responsible and informed use of the product. As a result, millions of satisfied consumers have enjoyed the convenience and economic benefits of payday advance services without complaint.

Myth: Payday lenders loan money to people who cannot afford to pay it back.

Reality: While customers may not have the ability to repay when taking out the advance, the allegation that lenders do not consider a customer’s ability to pay is completely false. All reputable payday lenders have underwriting criteria, in addition to the requirements of a steady income and checking account. More than 90 percent of payday loans are repaid when due, a fact confirmed by numerous state regulatory reports. It simply would not make good business sense to loan money to people who can't pay you back.

Myth: Payday lenders use coercive collection practices.

Reality: CFSA member companies are committed to collecting past due accounts in a professional, fair and lawful manner. In accordance with CFSA’s best practices, companies may not pursue criminal actions against a customer as a result of the customer’s check being returned unpaid. If it becomes necessary and is appropriate, however, companies may turn the account over to a collection agency.

Myth: Payday lending has grown dramatically because of aggressive marketing.

Reality: Payday lending has grown as a result of consumer demand and changing conditions in the financial service marketplace. Traditional financial institutions exited the small-denomination, short-term credit market, largely due to the high administration costs. At the same time, the cost of bounced check fees, late payment penalties, and other short-term credit products soared. Consequently, the demand for small denomination and short-term loans grew substantially. Additionally, legislation was enacted to provide regulations and consumer protections for payday advance customers.

Myth: Payday lenders hide fees and mislead consumers.

Reality: The cost of a payday advance is fully disclosed to customers on signs in the stores and in disclosure agreements. Moreover, in accordance with the Truth in Lending Act (TILA), the terms of the loan are clearly outlined in the lending agreement. Payday advances involve single, flat fees and there are no hidden charges, balloon payments or accruing interest. CFSA members also provide an educational brochure emphasizing responsible use of the product and offer a free right of rescission should the customer change their mind.

In a recent survey, 96 percent of payday loan customers said they were aware of the finance charge. A recent study by the Annie E. Casey Foundation found that, “Customers do make a cost analysis in comparing the price of a payday loan with the alternatives…”

Myth: Payday lenders take advantage of military personnel.

Reality: Payday lenders do not target any particular segment of the population. However, out of concern for our military customers, CFSA appointed a military advisory council to develop a code of military best practices by which our members must abide.

A survey of active-duty military personnel conducted by Penn, Schoen & Berland Associates found that only 3.69 percent of military had taken out a payday advance in the last five years – and only 1.18 percent had an advance outstanding.

Myth: Anti-payday lending activists have consumers’ best interest in mind.

Reality: While they claim to represent the best interest of the consumer, anti-payday lending activists seek to limit the already small number of short-term credit options available.

The reality is that anti-payday lending activists do not represent the views of millions of people who use payday advances responsibly and are glad to have somewhere to turn when they need quick access to credit.

Myth: Consumers win if payday lenders are regulated out of business.

Reality: Critics’ allegations that consumers are better off without this option is far from the truth. Anti-business activists should not be in a position to determine what is right or wrong for hard-working Americans. So-called consumer groups and activists working to ban the payday advance industry do not represent the vast majority of consumers who work hard to make ends meet. The bottom line is that consumers don’t want others making decisions for them. And they especially don’t like the idea of people (who have probably never been short of cash) dictating where they can or cannot borrow money. If critics are successful in regulating the industry out of business, consumers will be forced to turn to offshore Internet and often unregulated rogue lenders for their short-term credit needs.

At the end of the day, consumers win when given a variety of options and trusted to make financial decisions based on what’s best for them and their families.

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