Payday Loans – Lender of Last Resort

| October 8, 2007

The Federal Reserve on Friday reported that consumer credit rose at an annual rate of 5.9% in August, the biggest increase in three months. The increase in consumer credit was led by an 8.1% increase in revolving credit, which is the category that includes credit cards. Non-revolving credit, which includes auto loans, also rose at a faster pace, increasing 4.7% annualized, compared with 3.1% in July and 4% in June. Overall, consumer credit rose by $12.2 billion to a record $2.469 trillion.

One could guess that as the housing ATM has been shut off by contraction in the credit market, consumers have turned to their plastic to support their inflated lifestyle, and there is evidence to support that.

However, it should be noted that for a whole other class of consumers, they have turned to shops known as “Payday Lenders” as their lender of last resort (from Center for Responsible Lending):

Payday lending (sometimes called cash advance) is the practice of using a post-dated check or electronic checking account information as collateral for a short-term loan. To qualify, borrowers need only personal identification, a checking account, and an income from a job or government benefits, like Social Security or disability payments.

Research shows that the payday lending business model is designed to keep borrowers in debt, not to provide one-time assistance during a time of financial need. According to CRL’s research, borrowers who receive five or more loans a year account for 90 percent of the lenders’ business. Our latest report, Financial Quicksand, shows that payday lenders cost American families $4.2 billion every year in predatory fees. Eleven states are projected to save a collective $1.4 billion in 2006, offering hope and an effective solution — a cap on interest rates for consumer loans in the 36-percent range.

Payday loans typically charge fees equal to 400% APR, believe it or not! These lenders make most of their cash by making a set of serial loans to people who have run out of money, but for some reason cannot reduce their commitments or lifestyle. The Center for Responsible Lending estimates that 75% of payday customers are unable to repay their loan within two weeks and are forced to get a loan “rollover” at additional cost. “Trapped on the “debt treadmill”, many consumers get a loan from one payday lender to repay another,” the CRL says.

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Category: Credit Backlash, Economics, Recession Watch

About the Author ()

Bruce Henderson is a former Marine who focuses custom data mining and visualization technologies on the economy and other disasters.

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