Short-term loan lending came under controversy after consumer rights advocates pressured lenders to eliminate the high cost of short-term loans, such as payday installment loans. According to those against short-term loans, consumers are at risk of predatory lending practices and consumer debt spirals (getting new loans to pay off the old ones). These critics demand, if not total eradication of short-term loan lending, strict lending regulations.
In the middle of 2008, lending regulations were promulgated in several states in the U.S, to protect consumers from predatory lending practices. Consumer rights advocates argue that short-term loans, such as payday installment loans, take advantage of the financial situation of uninformed borrowers by creating “debt spirals.” Debt spirals arise from repeated borrowing to pay off old ones. The problem with this lending practice is that getting a new loan to pay the old loans is more expensive since you are paying more than the original loan amount.
Critics of short-term loan industry have written about several dangers of loan lending. However, could these lending regulations and restrictions protect the consumers or work to their disadvantage? A study was conducted to review and examine the effects of lending regulations on short-term loans. Here are the results:
- In states that allow short-term loan lending, regulations may indirectly restrict or effectively ban the practice.
By the end of 2008, many states have imposed lending regulations on short-term loans. Other states have passed lending regulations that indirectly ban payday lending by making it unprofitable. Variations on the regulations on the maximum dollar amounts to be loaned and imposition of fees varies depending on the state.
- Restricting short-term loans forces consumers to seek other credit alternatives that may be more risky and costly.
When short-term loans are unavailable, people can still use of their credit cards to get cash advances in times of need. However, the fee for cash advances on many credit cards has recently climbed to 4% to 5%, and the interest rates average 25%, generally higher compared to taking out a payday installment loan. Transacting with pawnbrokers may be costly, too. An analysis of pawn broking was conducted in 2006 wherein it was revealed that the median cap on interest rates was 15% per month, higher compared to short-term loans.
- Without a payday installment loan, the many people may end up paying late charges on utility bills, exceed their limits for credit card borrowing, and pay penalties for insufficient funds or bounced checks in the bank.
In fact, in 2010 bounced check fees averaged to $30.47. Another study revealed that the median interest rate on bounced check or overdraft fees are 20 times more than that of the interest rate in payday installment loans. The highest rates result from bouncing multiple checks for small amounts because a fee is charged for each bounced check. In addition, being late or defaulting on many other payments will affect your credit score.
Lending regulations on short-term loans may result in denying consumers from having access to instant cash, limit their ability to maintain a good credit standing, or compel them to seek more costly credit alternatives. Therefore, lawmakers should carefully decide on the legal actions they will make regarding regulations on short-term loan lending.