Bank Fees vs. Payday Loans: How Predatory Practices Really Compare

Many banks and consumer groups have been giving payday loans a bad name; however, studies show that this service prevents many from using resources that are more expensive and have greater long-term financial consequences.  

MINNEAPOLIS, April 9, 2013 /PRNewswire/ — Government and consumer groups have been putting pressure on the payday loan industry in recent years because of the high interest rate charged for the short loans. Although this type of financing is not right for everyone, the service is ideal for some consumers who NeedCashNow.org. Studies have shown that when this option is taken off the table, it has adverse financial consequences for families in need.

North Carolina and Georgia had a statewide ban on payday loans, which left consumers without realistic options for fast cash. The US Federal Reserve Bank released a Staff Report in November 2007 that examined the effects of this ban. It found that the prohibition on these lenders forced borrowers to seek more expensive and less favorable alternatives for emergency funds, such as bank overdrafts that lead to more severe long-term problems. Households in Georgia also bounced more checks, complained more to the Federal Trade commission about lenders and debt collectors, and had higher rates of filing for Chapter 7 bankruptcy protection than all other 50 states at this time. Households in North Carolina had comparable rates.

In January 2007, the New York Federal Reserve Bank Staff Reports released the "Defining and Detecting Predatory Lending" study, which concluded that payday loans ultimately benefited consumers. They found that these short term loans provided "preferable alternative" credit where only more expensive options previously existed and they did not negatively affect the long-term wellbeing of consumers. It found that they helped households "better manage their finances" and those that used them "are less likely to have missed a debt payment over the previous year."

Payday loans provide a unique service by loaning immediate funds for people in emergency situations. Traditional banks and credit unions, who are tightening their lending practices, cannot approve and grant access to cash the same day. Moreover, their fees are annualized, the interest rate would equal or surpass those of an average fast cash loan. Note the following:

• If the average insufficient funds fee was charged for a bounced check, the annualized interest rate would be about 100%
• If the general late payment for a credit card fee were annualized, the interest rate would be over 700%.
• If the usual reconnect charges and late fees from an average utility company were charged, the annualized interest rate would be near 1300%.

Payday loans may not be right for everyone; however, they are indispensable for those who need emergency funds to cover bills. Taking away this option leads to use of resources that have higher penalties and more serious long-term financial consequences.