Batchelder, Hagan Wrong About Payday Loans

By Marc Kilmer, posted March 20, 2008

* Marc Kilmer is the author of the Buckeye Institute study Payday Lending: Consumer Choice vs. Over-Regulation.

Ohioans did not send legislators to Columbus to make their personal financial decisions for them. Considering the poor state of Ohio's budget, it seems ironic that some in Columbus think their time is best spent focusing on the financial choices of others. Unfortunately, a few legislators want to spend the General Assembly's time targeting payday lending instead of fixing the serious tax and budget problems which plague the state.

Payday lending involves borrowers taking short-term loans by putting up future paychecks as collateral. It is an increasingly popular option for some, although it has found critics looking to blame some of Ohio's economic problems on it. In reality, though, these loans are not a "net drain" on our economy. Payday loans are the same as any other loan -- a borrower gets one amount of money with an agreement to pay a larger amount of money back to the lender.

The main difference between payday loans and other loans is that payday loans are for very short time periods -- usually two weeks -- and are offered to people who have credit issues and other financial problems. As economists who study lending will tell you, these types of loans have high overhead. The default rate is also much higher than other loans.

What that translates into is relatively high fees on loans. But just because an interest rate looks like a lot of money does not mean that it is unjustified. People want these short-term loans and they willingly agree to pay the fees and interest charged.

How much are these fees? In a recent column, Representatives Bill Batchelder and Robert Hagan claimed that these lenders charge a "391 percent interest rate."  However, a closer look finds something different.  In Ohio, almost all payday lenders charge borrowers $15 per $100 borrowed. That is an interest rate of 15%. If one assumes that a borrower takes a payday loan for a year, then it is possible that the yearly interest rate could add up to 391%. But since these loans only last for two weeks, the only accurate way to describe the interest rate is 15%.

Reps. Batchelder and Hagan are also forwarding legislation to regulate these loans.  They say the bill merely caps unreasonable rates. And, they say "efficient businessmen" can still make a profit under their proposal to allow lenders to only charge $1.50 per $100 borrowed on a two-week loan. However, testimony from people who actually run these businesses and economists who study this industry is almost unanimous in saying that current rates and fees are essential to pay the lenders' overhead.

Of course, there is nothing stopping lenders now from charging the interest rate proposed by Reps. Batchelder and Hagan. If consumers were really being exploited by lenders as these legislators claim, then why hasn't an enterprising businessman entered the market to attract these customers at a lower interest rate? After all, according to our legislators, a smart businessman could still make a profit. And since no one willingly pays high interest rates, current borrowers would flock to this lower-priced lender.

The answer is no lender could survive at these low rates because of their expensive overhead costs and the high default rates on these loans. On the borrowers' side, lower-priced loans do not seem to be important. Numerous surveys show that payday borrowers care more about convenience than the price of the loan. In short, as with every other economic purchase, people who take payday loans see the costs as being worth the benefits.

The common retort is that these lenders "trap" people into unmanageable debt. It is certainly true that many people take out multiple payday loans over the course of the year. When economists analyze why people do this, however, they find that the borrowers' underlying financial situation leads them into this behavior. It is not payday loans causing their financial problems. Instead, their financial problems lead them to seek payday loans. If legislation eliminates payday loans it will not eliminate the underlying financial problems of borrowers.

The attacks on payday lending do not bear up under scrutiny. Instead of wasting time on this issue, legislators should focus on the real financial problems facing Ohio. These problems do not come from payday lenders -- they come from the high taxes and high government spending that is dragging down the state economy. If they truly want to help financially-strapped Ohioans, the state's outdated tax code is a much better target than a few businessman offering short-term loans.

Marc Kilmer is a policy analyst with the Buckeye Institute for Public Policy Solutions, a research and educational institute located in Columbus, Ohio.