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The Unintended Consequences of Payday Loan Regulation

hundred dollar bill being cut by scissors
America’s current approach to payday loan policy is that there isn’t a current approach to payday loan policy.

While the federal government did “protect” soldiers from the potential pitfalls of payday loans with the Military Lending Act of 2007, there hasn’t been any type of federal legislation approaching that level of regulation for civilians.

On a state-to-state level, payday loan regulation is a patchwork of regulatory levels ranging from draconian stifling to a hotbed of open lending activity.

Of course, certain states think that simply “regulating” the payday loan industry isn’t enough. These states have instead resorted to the outright banning of payday loan financing. However, as America discovered during the Prohibition Era, and as America may even be realizing now with the War on Drugs, simply making something illegal does not erase demand. Rather, it may drive consumers to seek other ways to access what their state governments have decided to be illegal.

Certain states maintain a balance, in essence being hybrid states where regulation permits the payday loan industry to operate under certain restrictions. Unfortunately for the payday loan industry, vocal opposition groups are campaigning against them in the “Payday Loan War” that is raging across the country.

Just what do these groups wish to accomplish? They desire the heavy regulation, if not the total prohibition of borrowing payday loans.

They’ve already claimed victories in several states, yet how did these so-called “victimized” borrowers fare in the months and years after the payday loan bans took effect?

Jamie Fulmer, Senior Vice President of Public Affairs at Advance America, explained to loans.org just how ineffective these bans have proven to be.

“In every case, without exception, interest rate caps and similar restrictions to short-term lending have resulted in a higher number of consumer complaints due to unlicensed, unregulated lending, and an increase in insufficient funds (NSF) and overdraft (ODP) fees to banks and credit unions—fees that are often more expensive than our product,” he said.

Non-industry statistics and data proved him right.

The Cold Hard Truth

In fact, the Urban Institute found that prohibiting payday loans only led to a 35 percent decrease in payday loan usage. Driven to obtain credit—desperate even—consumers drove across state lines and borrowed cash advances online from unlicensed sources.

Clearly, regulators did not intend for consumers to borrow in neighboring states, let alone borrow online payday loans.

The Kansas City Federal Reserve echoed the Urban Institute’s findings. Its own 2007 publication found that 50 percent of consumers said that payday loans were their only option for short-term funds.

Hypothetically, a person without access to their only form of borrowing can end up jobless, homeless, or without a vehicle. For those who need money for rent or car repair, a payday loan can very well be the last resort. In the event of full-blown regulation, these respondents are simply left to their fate by lawmakers that oppose payday loan borrowing.

The publication used Georgia as an example.

Rotting in the Peach State

In the middle of 2004, Georgia banned payday lending. Between the middle of 2004 to the middle of 2008, traditional borrowing actually remained lower in Georgia compared to the rest of the country. It only grew by 25 percent while across the country it grew by 36 percent.  

If Georgian regulators intended to have the former so-called “oppressed” payday loan borrowers rush to the arms of traditional lenders after they ban, then they failed.

The New York Federal Reserve also found that the situation in North Carolina was no better.

A payday loan ban took effect in that state in December of 2005. However, following the ban there was a rise in complaints against lenders. There was more than a two-fold increase in complaints against debt collectors.

“Other states including Montana, Washington, and Arkansas have reported similar results: complaints skyrocketed as consumers turned to unlicensed lenders that charge astronomical interest rates and operate outside federal and state law,” said Fulmer.

Even when similar financing was available, it was considered undesirable.

A Darker Road Ahead

Regulators should be frustrated by the findings of the Cato Institute, which discovered that 55 percent of polled payday loan borrowers would rather borrow a payday loan than an identical product offered by a bank or credit union.

Worse still, regulators should be outright fearful of another alternative.

A research report from the Mercatus Center at George Mason University warned that consumers who are robbed of payday loans “may land in the arms of loan sharks and other black-market operators, or they may resort to financing their expenditures via illegal, dangerous, or risky endeavors.”

Clearly, a rise in illegal transactions would do no benefit to state or the national economy, let alone the wellbeing of communities.

“The bottom line is that these attempts to over-regulate short-term lending harm consumers by eliminating a critical option for those in need of occasional short-term, small-dollar credit,” said Fulmer.

The numbers don’t lie and if they could talk, they would certainly agree. For the sake of consumers, hopefully regulators will also agree sooner rather than later.