In economic terms, welfare is defined as the overall well-being of an individual. According to a staff report recently released by the Federal Reserve Bank of New York, payday lending may actually increase a household’s welfare. (It is noted that the views of this report do not reflect the views of the FRB of NY or the Federal Reserve System.) The paper claims that because of the alternative credit source that is provided, a household will be better off. Households that do not have access to traditional lines of credit through established financial institutions are most likely to seek these alternative forms. These households sometimes include long-standing credit union members.
A member’s financial well-being should be a top priority for any credit union. If this is the case, then why are some members still obtaining loans from third-party payday lenders? Payday lending is a cycle in our communities that must be broken. Common sense says that a member is not better off seeking loans from a payday lender, and therefore welfare is not increased no matter what a theoretical study may conclude. Instead, consumers should seek education from the credit union on how to improve their credit standing and have a loan officer that is an advocate for them rather than for the business.
Payday lending has grown to a $40 billion a year industry with 22,000 U.S. outlets according to the Community Financial Services Association of America. Compare this to the approximately 13,000 McDonalds locations around the United States (McDonalds.com), and their reach is evident.
From an example given in the study, let’s say the typical payday loan amount is $300 per two-week period. An average fee of $15 for each $100 increment is charged, resulting in a 390% APR. While this is a typical loan, some fees at certain payday lending outfits amount to a 1,000% APR. Personal, unsecured loans (excluding credit cards) at credit unions run at an average rate of 12.2%, a significantly lower rate than what payday lenders offer.
In addition, payday loan fees tend to not just be one-time fees. According to a Wall Street analyst interviewed by Consumers Union (the non-profit publisher of Consumer Reports), the average payday loan user makes approximately 11 transactions per year. This shows that once a consumer takes out their first payday loan, they become trapped in a lending cycle and find it hard to escape.
Perspective from the Payday Lending Industry
The owner of a payday lender in Colorado went so far as to say that he expected all of their customers to eventually default, according to an interview with Consumers Union. If this is the view of the industry, then they are certainly not interested in helping them improve their welfare. This is where credit unions can enhance their position as the “good guys” in financial services and be an advocate for these consumers.
Credit unions like Langley FCU ($1.2 billion in Hampton, VA) have established payday lending programs which are much better for members yet still profitable for the credit union. Compared to the 390% APR discussed before, Langley’s QuickCash program features an 18% APR which leads to huge member savings. This is in addition to helping them build a relationship with the credit union with someone looking out for their financial well-being.
Along with legislation pending in states across the country that could cap the amount of payday loans and/or fees, national legislation is pending that would cap the interest rate for military personnel wishing to receive similar loans. With these actions and more credit unions being proactive in this area, a difference can be made and the welfare of individuals across the country can truly be improved.