Payday loans create a cycle of debt that diminishes the income of vulnerable households
Marketed as short-term relief for a cash crunch, payday loans carry annual interest rates of 400 percent and are designed to catch working people – or those with a steady source of income such as Social Security or a disability check – in a long-term debt trap.
The terms are set so that borrowers most often cannot pay off the loan on payday when it's due without leaving a large gap in their budget, often forcing them to immediately take out a new loan after paying the first one back. One recent study found that people who took out payday loans nearly doubled their chances of filing for bankruptcy. These households' higher bankruptcy risk exists even when compared to households with similar financial status who were denied a payday loan.
Overdraft fees burden the same people: those living paycheck-to-paycheck. Banks and credit unions routinely approve uncovered transactions without warning their customers of a negative account balance, and charge an average $34 fee for each incident, even when the uncovered purchase amounts to just a few dollars.
Do borrowers pay more in overdraft fees when payday loans aren't available?
Payday lenders argue that working people are better off getting a payday loan than overdrawing their account, and claim that meaningful curbs on abusive payday lending, such as a 36% rate cap, will only increase the number of overdrafts incurred by cash-strapped families. This does not bear out—payday loans and overdrafts are not substitutes for each other. Rather, as shown in a University of North Carolina study of low- and moderate-income families—and the industry's own surveys—payday borrowers tend to have a variety of options besides a taking payday loan or incurring an overdraft fee.
In reality, most overdrafts are accidentally caused by small debit card purchases of about $20, not larger checks which might be used to pay an important bill. Very few bank customers knowingly overdraw their account—in a 2006 CRL survey, only five percent of accountholders reported ever using their debit card or writing a check when they knew there were not enough funds in their account to cover the transaction.
Additionally, a new study by Bretton Woods, a private consulting firm which lists the payday lenders' trade association as a client, shows no evidence that households in states without payday lending incur greater overdraft or NSF fees than households in other states. For example, two-thirds of the states without payday lending pay less than the national average in overdraft/NSF fees, and the share of household income spent on overdraft/NSF fees is the same or greater in states with payday lending, as compared to states without the product.
Payday loans don't prevent overdrafts – they increase them
Payday lending increases the odds that households will repeatedly overdraft and ultimately lose their checking accounts.
-Harvard Business School Study
Only five percent of accountholders have ever intentionally overdrawn their bank account to conduct a transaction.
-2006 ORC Caravan Survey for CRL
A study of OD/NSF fees by state provides no evidence of a connection between the presence of payday lending and OD/NSF fees incurred by households.
--Bretton Woods NSF/OD Fee Analysis
Not surprisingly, because payday loans are secured by a borrower's personal check or automatic electronic access to a borrower's bank, much of the available data suggests that payday lending may actually increase involuntary bank fees. Because one-quarter to half of all payday borrowers default in a twelve-month period, payday lending can actually spur overdraft fees.
In North Carolina, payday borrowers paid over $2 million in NSF fees to payday lenders in addition to the fees assessed by their banks in the last year their practice was legal. Moreover, a new report from Harvard Business School researchers finds that payday lending can increase the odds that households will repeatedly overdraft and ultimately have their banks close their checking accounts. Therefore, rather than lessening the impact of overdraft fees on a family's budget, payday lending can actually increase them.
Federal response to overdraft
Federal regulators and policymakers have recently turned their attention towards overdraft fee regulation. The GAO and FDIC have documented bank and credit union overdraft practices, and the Federal Reserve has proposed rules that would take steps toward reform. Federal legislation has also been proposed that would require that account holders have a clear understanding of the cost of overdraft programs, and that would prohibit banks from engaging in unfair practices such as clearing the day's transactions from the highest to the lowest in order to increase the number of fees they can charge.
State policy-makers can alleviate the overdraft problem – by addressing payday lending
A 36 percent interest rate cap for high-cost loans eliminates the predatory practice of charging 400 percent for loans to working people and will reduce the bank fees unnecessarily assessed because of faulty payday loans. A two-digit interest rate cap is already saving 15 states and the District of Columbia nearly $1.8 billion in predatory payday fees alone, and a federal 36 percent cap on loans to military personnel and their families has stopped the worst payday lender abuses of those serving our country. Our civilian working families are in dire need of the same protections.
Payday lending industry representatives have lobbied for other reforms, such as payment plans and renewal bans, because they understand that these measures have done nothing to slow the rate at which they can flip loans to the same borrowers. But an interest rate cap is the only measure that has proven effective.
Predatory payday lending needs immediate attention, especially in a time where preserving the purchasing power of working families is an essential part of economic recovery.