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Payday Loans as an Economic Indicator?

Are payday loans an effective economic indicator of financial health?

As an unscientific indicator of the financial health of this country, I have been watching the growth of “payday loan” outlets explode over the past twenty years. Since payday loans were first made legal in the 1990s, the number of outlets has increased to over 23,000 in the 23 states that allow payday loans. Compare that with approximately 12,400 McDonald's Restaurants or 11,000 Starbucks' and you get a sense of what I'm taliking about! Payday loan outlets cater to those financial consumers who cannot get a loan anywhere else. Face it: why would anyone pay an average fee of $17.50 to get a two week loan of only $100 if they had a better alternative? When you calculate the equivalent annual percentage rate on the average payday loan, that  comes to 455% per year!

Payday loans were first legalized in the 1990’s. The idea is simple: Allow almost anyone to take out a small loan and charge them a flat fee with a short deadline. The average loan is $350 and average loan fee is over $50. The borrower writes out a post-dated personal check and the payday loan outlet holds it until the original loan is paid off. The borrower must pay back the loan or the chek is then presented for payment. If the check bounces, then the consumer must deal with the consequences of a bounced check (and the fees from the check being presented to the bank at least twice). Many borrowers get into even more trouble by never paying off the original loan and instead paying the loan fee to take out another loan to pay off the first. This is called loan “churning.” Some outlets even offer this as a loan option, where the loan is automatically renewed, and a fee debited from the borrower's checking account, every two weeks indefinitely! A payday loan of $300, renewed five times before it is paid off, would amount to $315 in fees!

While its critics attack the payday loan industry as "legal loan sharks," representatives of the industry paints a far different picture, claiming the service helps people avert a cash emergency. "I really think that this industry is a classic example of the marketplace making a need that somebody or someone fills," says Vicki Woodward, a vice president for Advance America, a leading national chain of payday lenders. Woodward, who also serves as the spokesperson for the Community Financial Services Association of America, the trade group that represents most of the payday loan industry, says payday lenders fill a void left by banks, which do not typically offer small loans to troubled consumers.She also cites growing charges for bounced checks, ATM machine usage and credit card late fees as reasons for growth in the payday loan industry. It is worth noting that the fees associated with other emergency solutions are high as well: a late credit card payment could trigger a $37 fee, for example. Overdraft fees for checking accounts can be $25 or even more.

Regardless of the reasons why, and despite the reforms Congress has deployed, the industry will doubtless continue to flourish. As an economic indicator, the success of the payday loan industry runs counter to prosperity – and until the outlook for the poorest consumers and those unable to  qualify for other (cheaper) forms of credit improves – the success of the industry will continue.
Published Feb 22 2010, 06:11 AM by moneycoach
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