Are Payday Loans Better for Consumers than Overdraft Fees?

Both the pending Wall Street Reform and Consumer Protection Act include provisions that are expected to have significant effects on the payday lending industry. The provisions are the result of intense lobbying by consumer advocates that claim payday lending is predatory lending that targets low income people. The consumer advocates have waged war against payday lenders in Washington and numerous states on the premise that fees charged for payday loans amount to usurious interest rates that take advantage of consumers.

Despite these claims, there are commentators who make valid arguments for the value of payday lending services and how they meet the needs of millions of Americans. One commentator even makes the case that payday loans are cheaper than traditional lending options for a segment of consumers.

The latest study to bolster the argument that payday lenders provide valuable access to credit that can be more affordable than traditional lenders was authored by Michael Moebs, CEO of Moebs $ervices. Moebs $ervices is an economic research firm that specializes in collecting primary empirical data about financial institutions’ services, pricing, operating expenses and financial condition and analyzing the data in a counterintuitive manner that provides simple solutions to complex issues.

Moebs $ervices released a new study yesterday that finds that consumers who are frequently charged overdraft fees at banks and credit unions could save money by bridging their cash gap with a 14-day payday loan, rather than paying checking account fees. “The average amount overdrawn on checking accounts by about 70 percent of consumers, according to the General Accounting Office and the FDIC, is less than $100,” said Moebs. “Consumers who use a payday advance loan for $100 or less will pay an average of $17.97, which is 33 percent less than the $27.01 it costs for an overdraft of that same amount from a checking account,” he explained. “For consumers who struggle to meet their financial obligations, the savings between the two is significant.”

Lawrence Meyers is another commentator that believes that payday loans have a place in our economy. In his blog, FDIC Survey Proves There Is a Role for Payday Lenders, Lawrence Meyers writes about the FDIC’s Affordable and Responsible Consumer Credit program launched in 2007 where 30 banks agreed to offer short-term loans of up to $1,000, at a maximum APR of 36%. According to Meyers, the FDIC thought the program would prove that lenders could make a profit under these conditions while still serving the payday consumer’s needs at a lower price.

The results of the program were rather disappointing - only a few thousand loans were made compared to 100 million loans payday loans made each year. Why? Meyers says convenience. While payday loans are approved in a mere 15 minutes, the FDIC-sponsored loans typically took more than 24 hours to approve -- failing consumers who needed their funds immediately. Some bank loans required direct deposit and credit checks. Some banks even required financial literacy classes or collateral (a portion of the loan was left in the bank on deposit).

None of the institutions made a profit while some lost money, even with an origination fee of up to $50. In Meyer’s opinion, the only reason the 30 institutions participated in the program was for the “favorable consideration under the Community Reinvestment Act” their banks would receive.

Meyer argues that what is clear is the government program failed to serve the needs of people that use short-term lending. As he points out, most consumers know how to shop for the best deal, that is, the deal that best suits their needs. It certainly would explain why many consumers continue to make the choice of payday lender over their local bank.