The key to limiting the damage caused by payday lenders is tough regulations. Yet, the reason that payday lenders have proliferated in the first place is that there is a large need for small dollar loans. So, in addition to regulating payday lending we also need to increase access to safe, affordable alternatives. Expanding and promoting such alternatives will help to alleviate the financial burden on low-income and low-asset families.
Alternative small dollar loans need to be more than just payday loans lite. Instead they must be structured to ensure that they are safe and affordable. Not all payday loan alternatives are created equal. A new study from the National Consumer Law Center, which evaluated over one hundred existing products, found that there is a wide range of product quality from genuine alternatives and ones that come close to products that are merely payday loans disguised in a different name. Credit unions dominate the genuine alternatives, but some banks are also offering beneficial products.
The authors argue for a real alternative to payday loans that will fill a need for convenient, emergency credit without leaving consumers in worse financial shape than they began. The study clarifies several myths regarding alternative payday loans:
- Just because a product is slightly cheaper does not make it good. A real alternative must be truly affordable.
- A small profit margin does not equal a good product. Loans should be judged by their impact on the borrower.
- An alternative does not need to be structured like a payday loan. In fact, the classic high fee structure and short repayment period cannot be replicated if we are to create a genuine alternative.
- Expensive loans should not be tolerated because there is consumer demand. In many cases payday loans delay tough choices needed to get one’s personal finances back on track and instead can serve to make a bad situation worse.
Instead the report suggests that alternatives should contain the following characteristics:
- A genuine payday loan alternative must have no greater than a 36% annual rate, including interest and fees.
- A minimum of 90 days loan repayment term in manageable installments.
- Must not employ a security method such as electronic access to a bank account that puts money for food and rent at risk.
Hannah Weinberger-Divack coauthored this post.