The unnecessary death of payday loans

For a large chunk of Americans, the holiday season isn’t merry and bright. It’s a time of financial struggle, trying to figure out a way to put gifts under the Christmas tree while straining to pay everyday living expenses. Unfortunately, new regulations about to be released by the Consumer Financial Protection Bureau (CFPB) could make the holidays even tougher for some families.

Roughly one in four American households conduct financial transactions outside the mainstream banking system. Without a checking account or savings account, they lack access to traditional loans and credit cards, among other things. When these Americans need cash, their financial options are limited.

{mosads}To capitalize on holiday sales before their next paycheck or pay for emergency car repairs, many of these “underbanked” Americans turn to short-term, or “payday” loans.

Payday loans certainly have an unsavory reputation for charging high interest rates. But is the cost of a payday loan to consumers actually out of step with the cost to the lender?

Payday lending involves significant financial risk for lenders; they’re lending to customers often without the credit to qualify for less expensive financial options. As a result, payday lenders must charge higher interest rates and fees than traditional banks. A paper from the FDIC, “Payday Lending: Do the Costs Justify the Price?” concluded “We find that fixed operating costs and loan loss rates do justify a large part of the high APRs charged on payday advance loans.”

Several studies show payday loans don’t have a negative effect on borrowers’ credit scores. Instead, research suggests these short-term loans help borrowers avoid bouncing checks (which can cost more than a payday loan) and help borrowers pay their bills.

Despite these financial realities, activist groups are pushing the CFPB to impose strict limits on the interest rates charged by payday lenders.

Leading the charge for tighter regulation is the Center for Responsible Lending (CRL), a group founded by Herb and Marion Sandler. Though CRL says its mission is to stop “abusive lending practices,” the Sandlers earned their fortune by offering adjustable rate mortgages with monthly payments that ballooned by thousands of dollars. These adjustable and subprime mortgages led to massive defaults, as highlighted by “The New York Times”, “60 Minutes” and others, and have been blamed for significantly contributing to the 2008 financial crisis.

CRL wants to cap the annual interest rate for payday lending at 36 percent. However, this cap would effectively eliminate payday lending—as it has in states that have already instituted a 36 percent cap.

While this may sound altruistic, it turns out the CRL has a financial interest in eliminating payday loans. CRL’s parent organization is the Self Help Credit Union, which also offers short-term loans. A recent POLITICO report states emails between CRL and the CFPB show CRL was “pushing CFPB to support its own small-dollar loan product with a much lower interest rate as an alternative to payday loans.”

The irony is shocking. CRL’s founders peddled junk loans to people who couldn’t afford them, contributing to the housing crisis and Great Recession. Now CRL is lobbying to curtail short-term lending to vulnerable borrowers under the guise of stopping “abusive” practices, which will eliminate CRL’s competition while it peddles its own short-term lending products.

Sometime in the coming months the CFPB will release the final version of its rules, expected to limit interest rates charged by payday lenders and require lenders to ensure borrowers have the means to repay their loans. The rules are widely expected to put a majority of payday lenders out of business.

While such an outcome may benefit CRL and its Self Help Credit Union, it hurts the 12 million Americans who take out payday loans every year. Without access to regular banks or payday loans, many will turn to less regulated options such as pawn shops and loan sharks, or they’ll forego Christmas presents altogether. CFPB’s regulations are a lump of coal American families don’t deserve.

Joseph is a business professor at the George Washington University School of Business.