There is a new trend in lower income communities in the United States called payday loans. The popularity of getting payday loans to help to pay off utilities and short term debts. These loans have become controversial and brought on speculation of the ethics of the loans and their practices. There has been legislation brought through state senates on this issue but with heavy lobbying have not be able to see the light of day. The tactics of these lobbyists have also come into question. The overall question to be answered is if payday loans are good for this country.
II. What are Payday Loans?
Payday loans are defined on Investopedia as a short-term loan with a small borrowing amount and a high rate of interest. The way it works is the borrower writes a post-dated check for the borrowing amount plus a fee for immediate cash. The lender keeps the check until the agreed date which is normally the borrower’s next payday. These loans are also commonly called cash advance loans or check advance loans. (Investopedia)
These are attractive to lower income community because the loans offer them money right away before they earn it. The feeling of having physical cash in their hands makes them confident in themselves. This system is great if you can pay the debt off quickly but if you take just a small amount of time to pay the loan the debt can pile up. This is because these loans have a fee applied which pushes the total higher than the payday check combined with a very high rate of interest.
The fee is typically $17.50 per $100 for seven days but this then can becomes 900% on an annualized basis. The problem with this is that the fee adds onto the original principle which is based on the borrower’s payday check. This is a problem because the loan is made to be paid in full once the paycheck comes in. However, when payday comes the entirety of the principle is not paid off due to the fee. This is when the interest rate comes into play. With the unpaid principle the interest rate is applied raising it even higher. The interest rates on these payday loans can get up to triple digits in some cases. This causes the person to have to pay double or even triple what they borrowed.
For example, we have Bob who is a lower income worker that has the entirety of all his paychecks go to bills for his house. Now if Bob has a paycheck of $120 to be paid in two weeks and needs that money this week to buy his groceries then Bob would go to a payday lender. Now let’s say the fee for this lender is $20 and loans have an interest rate of 50% monthly. Bob would then would take out a loan for $140, the paycheck plus the fee, but write a check for $120, the amount of the paycheck. Once payday comes $120 of the loan would be paid off leaving $20 left still on the loan. The interest rate then applies to the $20 left over making it $30. This is because 50% of 20 is 10 plus the original 20 equals 30. The next month the $30 then becomes $45 which then turns into $72.50 and so on. Within 6 months after the original loan was taken out you have the principle now at $151 which is higher than the original $120. Now remember that all of Bob’s paychecks go towards bills that end up in him not being able to pay the principle off and the debt to continue to accumulate. The common solution to this problem is to take out another loan which restarts the whole process with a new fee and another 6 months of debt.
III. Is it Ethical?
The original purpose of payday loans was to help financially need individuals to get money to help pay bills before their paychecks came. Where the plan went wrong is that it didn’t end once numerous customers went into a deep amount of debt. It should have been a red flag for the payday lenders to fix this problem once the debt began to pile up on countless individuals who already had money problems. This becomes an ethical issue because…