Unfortunately, wherever there are powerless people, there are those who are ready and eager to exploit them financially in their time of need. This has grown to become a huge industry in America with the “payday loan” industry as the most visible, legal model. The most infamous illegal model is loan sharking. Unfortunately in most developing countries, the usury laws are less developed so loan sharking is still prevalent.
An even larger amount of high cost debt to the poor in the USA has been provided by credit card companies, but the absolute fees while high (15-25% in many cases plus various fees) are still significantly lower than the 200-500% for payday loans.
How are payday loans at these exorbitant rates legal? Isn’t this predatory lending? The lenders have gotten around usury laws by calling the additional repayments “fees”, not “interest.” So, you might borrow $300 with commit to repay plus $45 (15% premium) fee in one week. The APR for this loan is north of 400%! Plus if you don’t pay or your check bounces, the fees go even higher plus your credit history is blemished.
Are people using these loans for one-time emergencies? According to Legal Loan Sharks article, “The payday loan propagandists claim that this unexpected expense is their reason for existence, but, in reality, the regular customer is their bread and butter.” Many people are using this as a line of credit which they are forced to continue to use as they face the next shortfall in the following week. Just like credit card debt, it is an addicting cycle.
The issue is that the poor are being viewed exclusively (or at least primarily) as profit centers who can often be exploited because of their lack of information/knowledge or their dire need. And the only reason these credit services continue to grow so quickly is that they are immensely profitable. The credit providers argue that they need to have their high fees because of the higher risk and higher transaction costs for these customers. While it is true that overall that these customers are more expensive to service and some have higher risk, it is not clear that this fully justifies the fee structures which they put in place. For instance, there are very few options for a poor creditee to earn lower rates/fees even if they have demonstrated consistently meeting their commitments.
Slate’s article How the Other Half Banks: The depressing, amazing “payday loan” business provides a good summary of the industry.
How different this is from the socially-minded approach of the microfinance industry which is providing credit on reasonable and dignified terms to many of the poorest of the poor.
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