This week Congress is set to engage in a highly anticipated debate to raise the federal minimum wage from $5.15 to $7.25, the first possible raise in nine years. As it stands, the debate has focused on the impact of raising the minimum wage on employers and low-wage earners. Less attention has been focused on the recent explosion of the payday loan industry and its impact on low-wage families. The high fee and exorbitant interest rates of the industry continue to trap many low-wage earners and their families. Raising the minimum wage could increase families’ ability to save and help put a dent in their debt. Rethinking the low-wage structure is not just about allowing families to better afford life’s essentials; it’s also about protecting them from a debt trap that could forever hold them back from achieving the American dream.
The payday industry offers small-sum (between $200 and $500), high-fee ($15 to $35), short-term loans (generally two weeks) that result in annual percentage rates (APRs) that often equal or exceed 400%. Borrowers do not need to prove that they can pay back the loan within two weeks — only that they are able to produce a post-dated check, have some source of income and a checking account. The industry has exploded in the last decade, reporting $10 billion in sales in 2000 to $40 billion, including $6 billion in interest rates and fees, in 2003.
Because of the high-risk terms, borrowers often get caught in a vicious cycle of chronic debt. When they cannot afford to pay back the fees plus the principal at the end of the two week period, borrowers are forced to pay another high fee to roll over the loan for an additional two weeks or take out another loan to pay off the first loan, thereby getting trapped in a costly and often devastating cycle of “back-to-back” loans. Borrowers who renew their loans or take out multiple new loans often pay more in fees than they initially borrowed.
With such high-cost terms, repeat use of payday loans is often a debt trap for many families. A study published by North Carolina’s Center for Responsible Lending (CRL) finds that 91% of all payday loans are made to repeat borrowers who take out five or more payday loans per year. CRL further estimates that nearly five million borrowers are caught in this cycle of chronic repeat borrowing every year, costing low to moderate income families $3.4 billion in high fees and interest rates. The double whammy of stagnant wages and high costs suggests even a slight increase in wages that allowed families to put aside a small amount of savings could loosen the grips of chronic high-cost debt
While the industry continues to grow, states across the country have tried to regulate the industry with little success. Even states that have tried to implement all out industry bans, like North Carolina, have seen a nimble industry respond by peddling a new high-interest loan product called a “credit enhancement loan.”
Moving the discussion from how to regulate industry to what drives borrowers to payday lenders in the first place may be a more successful public policy strategy. Data from North Carolina suggest that a family’s dependence on payday lenders decreases when wages increase. Even a small increase in wages may provide the cushion families need to stay away from high-interest lenders. The current bill raises the minimum wage from $5.15 to $7.25 an hour, giving a worker an additional $4,200 over the course of a year. Assuming a family puts a percentage of this increase in income towards outstanding payday debt, even a dollar increase could help reduce a low-income family’s debt by as much as $350 over the average length of a typical loan — a significant amount for a family living paycheck to paycheck. Higher increases in low wages could also improve a family’s ability to access low interest loans, eliminating the need for payday loans.
The high risk and potential debt traps posed by the payday industry are extra incentive to provide low wage workers with higher, more reasonable wages and ensure greater access to the country’s middle class.
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