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Friday, January 8, 2016

Loans aren’t the enemy – It’s the debt mindset that gets us in trouble

Payday loans – those much-vilified short-term, high interest loans – are often the target of dire warnings from personal-finance gurus, particularly during the holiday season when so many people are going crazy with their spending anyway. 

Payday loans
Payday loans are often used on a short-term basis
Granted, the fact that hundreds of thousands of struggling families may be using payday loans to fund their holidays is a little unsettling. But are payday lenders really the villains they’re sometimes made out to be? Or is there a deeper cultural force at work that allows and even encourages so many of us to accept indebtedness as a way of life, with payday lenders being but one small part of the problem? Are many of us sabotaging our own financial well being by embracing a debt mindset?

In October 2015, a group of economists writing on the Liberty Street Economics blog (which is hosted by the Federal Reserve Bank of New York) made a case for reframing the debate about payday lending. The authors questioned whether the widespread enmity against payday loans is justified, arguing that the main problem is with repeated rollovers, which they speculate could be a result of consumers being overly optimistic about how quickly they can repay their loan.

This is not to imply that all criticism of the payday lending industry is invalid. Notwithstanding the arguments of the economists cited above, payday lenders have been justly criticized for charging usurious rates, for aggressively marketing to vulnerable demographics, for aggressive collection tactics, and for other practices that are only marginally legal and almost certainly unethical. But within the past couple of years the payday loan industry has been reined in via a series of laws and reforms in both the US and the UK, and to a lesser degree in Canada and Australia. The interest rates are still higher than those on more conventional loan products, but there are now more protections in place for consumers.

Despite reforms and restrictions, the industry is still thriving

Whenever some new consumer protection law or regulation is proposed, it’s very common for the industries affected by the legislation to protest. The payday loan industry has been no exception, with some major lenders in the US and other countries warning that they might be driven out of business by reforms. But the industry has not only adapted to reforms thrown at it thus far; it seems to be thriving.

Despite the fact that payday loans remain illegal in some states in the US, between ten and twelve million Americans a year use payday loans. Payday lenders are holding their own in the UK as well, and Sky News Australia reports that payday loans Down Under soared by more than 200 percent in November 2015, compared to the same month in the previous year. An Australian consumer advocate named Bessie Hassan blamed higher living costs, ubiquitous advertising and a boom in lenders, but she also said that over half of Australians were not adequately budgeting for the holiday season.

And that brings us back to the problem of the “enemy within” – the self-saboteur that can wreck our financial health no matter where we live.

Don’t just “roll over” and accept debt

In 2014 the Consumer Financial Protection Bureau (CFPB) published research indicating that four out of five payday loans in the US were “rolled over” or renewed within 14 days. The CFPB study also showed that the majority of all payday loans were made to borrowers who renewed their loans so many times that they ended up paying more in fees than the amount of the money originally borrowed.

In the year since that study was published things haven’t improved much. One problem is that most people use payday loans to cover everyday expenses, according to a report by Pew. Moreover they all too often take advantage of rollover features allowing them to extend the amount of time they have to pay off the loans. But they pay dearly for that extra time, as APRs on payday loans in the US are between 391 and 521 percent. This means that if you roll over a typical payday loan of $325 eight times, you could end up repaying a total of $793, according to the Center for Responsible Lending.

Some countries have placed stringent limits on the number of rollovers allowed on a single loan and have also imposed stricter price caps than exist in the US, where policymakers are still debating reforms. But there’s a lot to be said for the notion that real reform begins with the individual consumer. That’s not a blame-the-victim stance at all. Consumers certainly deserve protection from predatory lenders, but at some point they also have to take responsibility for their own financial health.

Just about any one of us could find ourselves in circumstances where we need cash and have few places to turn, and where a payday loan might be the best short-term solution. The key word here is “short-term.”

Get in and get out as soon as possible

Despite the high interest rates, a payday loan can sometimes be the best way to get out of an immediate crisis, particularly if your credit is less than stellar. But in order to keep the crisis from getting worse it is imperative that you handle the loan responsibly. The first step is to research your options; compare lenders so you can get the best deal possible. Reading about other customers’ experiences with the lender you’re considering can also help. It’s also important that you only borrow what you know you can afford to pay back on a timely basis.

And no matter how many rollovers you’re allowed, do your best to avoid them. It’s easy to get into debt and very often much harder to get out. And yes, payday lenders may encourage you to remain indebted. But that doesn’t mean you have to take the bait. Payday loans in and of themselves are not the enemy. The real enemy is a too-casual attitude towards indebtedness.