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A Word of Caution on Payday Loans

Payday loans end up being very costly for families, particularly minorities and those of low income, writes Raul Arce-Contreras.

A Dollarwise payday loan store is seen in Kent, WA. Payday loans end up being very costly for low-income and minority families in particular, making restrictions on these loans imperative along with more availability of other low-cost credit options. (AP/Ted S. Warren)
A Dollarwise payday loan store is seen in Kent, WA. Payday loans end up being very costly for low-income and minority families in particular, making restrictions on these loans imperative along with more availability of other low-cost credit options. (AP/Ted S. Warren)

Many families across our nation are accessing alternative forms of credit to make ends meet in the current economic crunch. But low-income minority communities in particular are turning to sources of credit as they run out of options. According to a recent report by the Center for American Progress that examined new data from the Survey of Consumer Finances, low-income and minority families are more likely to utilize a type of lending know as payday loans, which can prove to be a debt trap for these families and financially set them back even further.

Payday loans are short-term, high-interest loans that require only a steady source of income and a checking account as a guarantee. Typically, a borrower takes out a small loan of several hundred dollars and must pay it back in full—plus a fee—by the time their next pay period ends. If the borrower is unable to pay the loan in full on time, he or she can either “roll-over” or renew the loan for a fee, or bounce the check and incur bank and other fees.

Payday loans are advertised as providing convenient short-term lending, but they can quickly turn troublesome for many borrowers who must take out recurring loans if they are unable to pay off the first loan. And many times the costs of recurring loans for the borrowers exceed the amount of the initial loan. According to a 2008 Center for Responsible Lending issue brief a typical borrower may have to pay $500 in fees for a $300 loan. Annual interest rates for payday loans average over 400 percent and recurring loans allow the industry to collect $4.2 billion annually in fees nationally.

According to the CAP report,"Who Borrows from Payday Lenders?" typical payday loan borrowers include low-income households and those headed by minorities and single women. In the case of minorities this may not be a coincidence: A study released in March by the CRL entitled “Predatory Profiling” shows that payday loan companies actively target minorities by placing branches in communities where African Americans and Latinos tend to live. The study, which focused on California, found that payday lending centers are eight times more concentrated in majority African-American and Latino neighborhoods than in white neighborhoods. The industry collected about $247 million in fees from these communities in that state alone.

Prior research by the CRL also found that 36 percent of payday loan borrowers were Latinos in California and 34 percent of borrowers in Texas were Latino, too. Both those states have the largest Latino populations in the country, and in both cases, the percentage of Latino payday loan borrowers exceeded their share of the population. A similar pattern was seen for African Americans. Since low-income minorities are overrepresented as payday loan borrowers, they run a higher risk of falling into the downward spiral of these loans.

Currently the only federal law capping the interest rate that can be charged on a payday loan is the Military Lending Act, which only applies to active-duty military families. The Federal Deposit Insurance Corporation also outlawed the “rent-a-bank” practice in 2005, which closed a loophole that allowed payday lenders to partner with banks to avoid restrictive state regulations. Legislation that proposes a national cap and better regulation of payday loans was reintroduced earlier this year, but for now regulating the industry is up to the states.

Community groups and informed citizens around the country have put pressure on local lawmakers demanding more regulation of the payday loan industry, especially in Arizona, California, and Texas, which all have significant minority populations. Some state legislatures such as Massachusetts and New York have responded to this pressure by placing caps on short-term loan interest rates, while some have prohibited payday loans altogether. But as the CRL’s “Predatory Profiling” report points out, California—where there are a high number of minority payday loan users—has yet to place any caps on short-term lending interest rates.

“Policymakers are concerned about payday loans because of the high costs associated with them,” said Amanda Logan, a Research Associate who co-authored the report for CAP with Christian Weller. “Recently, bills have been introduced at the national level but the state level is definitely where we’re seeing a lot of movement [on payday loan legislation].”

However, Logan cautions that increasing restrictions on payday loan services must be done carefully.

As she points out in the report, most people take out payday loans not because it is the only option available for them, but to cover an emergency, to pay for basic consumption needs, and for convenience. Restrictions on payday loans should therefore be balanced with other, lower-cost credit options for families in addition to more savings opportunities. Doing so would help prevent predatory practices in the industry while still giving families a way to access credit whey they need it and put more money away that can be used instead of taking out loans.

Raul Arce-Contreras is a Press Assistant at American Progress.

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