OPINION: Missouri's Payday Loan Popular Vote Initiative

A ballot measure in Missouri aimed at capping payday loan interest rates at 36% would effectively "break" the cycle of debt that entraps poorer families, according to the initiative's supporters. There are unanswered questions, however, about the effectiveness of the proposed cap as well as its adverse effects on the consumers and employment in the state.

The Background

It is no secret that the main problem that people have with payday loans is their affordability. Here is paradox: people who generally cannot afford a payday loan are the ones looking for one. A payday loan can be compared to Viagra or coffee - there is the same level of urgency. It is in times of financial distress and very few options left that consumers seek payday loans. And the laws of economics would predict the ubiquitous nature of payday loan operators, just like of Starbucks coffee shops. It is the same principle at play.

According to the conducted by Missouri Finance Division in 2007, the average income of consumers taking out payday loans was $24,607 and 12% were on SSI or disability! The average rollover rate (the number of times a loan was renewed/extended) was 1.7. The devil is in the details, of course. The averages won't tell us much. And while the income figure might point to some difficulties that may arise in repaying a typical $100-$500 loan, it is the rollover rate that is to blame, for the most part. We can also assume that due to the overall poor economic performance, the above statistics only got worse.

The ability to extend a payday loan is what gets people in "debt trap". It is seemingly an innocent practice: you simply pay the finance charges and a small amount towards the principal (e.g. $50). So, for example, for a $300 loan you may need to pay $90 (finance charge) + $50 = $140 in two weeks and roll over the remaining $250 to the next payday (for another two weeks). Just like with credit cards, the lender is actually making more money by allowing you to roll over your debt! 

FYI: None of the states neighboring Missouri allow payday loans to be renewed.

Now, why would one need to roll over their debt? Because they have no money to pay it back! And, this simply implies that they will look for further loans just to cover their roll-over fees. So, the problem boils down to the three main issues:

1. The loan rollover option
2. New loans taken when old ones unpaid
3. Lack of financial responsibility on the part of borrowers

While we can certainly see how taking a payday loan is still a choice in a free society, there are conditions in place that make this choice prevail.

The 36% APR Cap

What effects would a 36% cap have if passed? It is not difficult to make a guess that many payday loan operators would go out of business. This is due to high default rates and operational expenses. This, in turn, would lead to lay offs by large payday loan companies such as QC Holdings that is currently under investigation by FTC. Whether this adverse effect on employment could be counter-balanced by new jobs created as a result of lower expenses incurred by payday loan customers is a good question.

The recent Keystone Research Center report argues that consumers who are turned down by payday loan lenders are less likely to file for bankruptcy than those who are actually approved. At the same time, Federal Bank's of New York "Payday Holiday" report that studied consumers in states like Georgia where payday lending is banned, found that people bounced more checks and filed for Chapter 7 bankruptcy at a higher rate. Also, there are accounts of people in those states turning to illegal offshore online operators in search for a loan which puts them at higher risk of identity theft and financial abuse.

In my opinion, setting a cap that would effectively eradicate payday loans altogether could be counterproductive in light of the issues discussed above. Both "push" and "pull" factors should be addressed through an orchestrated legislative initiative that would take into account the interests of payday lenders, consumer groups and ordinary Missourians who rely on payday lending.  

If you need to apply for a payday loan, make sure you do the research, read payday loan reviews online. To file a complaint against a bank or lender, or to ask general questions about financial issues, you can contact the Division of Finance at 888-246-7225 or visit finance.mo.gov.