February 26, 2013

Click here to view and here to listen to Jon Sanders discussing this Spotlight report.

RALEIGH — North Carolina’s ban on small-scale, short-term lenders or payday lenders hurts potential borrowers more than it helps them. That’s a key conclusion in a new John Locke Foundation Spotlight report, which recommends that North Carolina legalize these kinds of loans again.

“Getting rid of payday lending in North Carolina left consumers worse off, as Federal Reserve Bank research has shown,” said report author Jon Sanders, JLF Director of Regulatory Studies. “The ban led to more bounced checks, more complaints about lenders and debt collectors, and more filings for Chapter 7, or ‘no-asset,’ bankruptcy than there would have been had payday lending been allowed.”

North Carolina exempted payday lenders from state usury laws in 1997, but lawmakers allowed that exemption to end in 2001. State regulators helped shut down the last storefront lenders in North Carolina in 2005.

“Despite the existing state ban, 5 percent of North Carolinians still take out high-cost, short-term and payday loans, going either to storefronts across state lines or online to unlicensed vendors,” Sanders said.

Senate Bill 89 would legalize payday loans again in North Carolina. Filed earlier this month with Republican and Democratic lead sponsors, the bill sits in the Senate Commerce Committee.

Sanders’ report counters key arguments made against payday lending. “Essentially, the concern boils down to the view that these lenders prey on poor borrowers and make them agree to exorbitant rates that leave them needing to take out subsequent loans — what critics label a debt trap,” Sanders said. “Critics also highlight payday loans’ high effective annual percentage rates, or APR. Although it is a questionable practice to define a short-term fee in terms of effective APR, critics use those numbers for shock value.”

Opponents ignore some key facts, Sanders said. “The state’s existing ban is especially harmful to those with the fewest options when they face an immediate shortfall,” he said. “Their remaining options — bounced checks, overdrafts, late fees, illegal loans from loan sharks — may be more expensive.”

“While aimed at saving people from making harmful choices, on the assumption that they don’t know any better, research shows the ban on payday loans imposes a net greater harm instead,” he added.

Fees vary based on the amount of money borrowed, but a fee of $15 for every $100 borrowed is typical, according to Sanders’ report. “That high cost owes to two unique aspects of the loans: their high-risk clientele and the fact that the loans involve small sums lent for short periods of time,” he said. “The fees charged are essentially break-even prices once default rates are factored in. The industry is not that profitable, as one would assume it would be if the fees were outrageous or predatory.”

Borrowers dislike the high fees, but that’s not the only factor they consider when choosing to take out a payday loan, Sanders explained. “Customers prefer the quickness and ease of obtaining the loans, their discretion and the lack of embarrassing interactions with family, friends, employers, and creditors,” he said. “They also appreciate that payday loans involve no credit risk.”

Research shows consistently that payday borrowers understand the costs involved, Sanders said. “Borrowers make rational decisions when they choose short-term loans,” he said. “Ninety-five to 97 percent of the loans are repaid. Instead of needing protection from predatory lenders, borrowers need protection from paternalistic policymakers and their negative unintended consequences.”

Critics argue that a $15 fee for $100 borrowed for a two-week loan translates into an effective APR of nearly 400 percent. “Those same critics say nothing about bounced-check fees, which can have an effective APR of 700 percent with overdraft protection and 3,500 percent without that protection,” he said. “Utility disconnect and reconnect fees can have an effective APR ranging from 240 percent to 420 percent. For credit card late payments, the number can be 965 percent, while it’s impossible to pinpoint the effective APR for someone who feels forced to borrow money from a loan shark.”

Legalizing small-scale, short-term and payday lending could take into account consideration of the industry’s best practices, Sanders said. “This could include full disclosure of rates, a limitation on rollover of loans, appropriate but nonabusive collection services, no criminal prosecution for lack of payment, and the offer of an extended payment option.”

Sanders also noted a potential positive economic impact. “Legalization would lead to job creation across the state, as it would undo a ban that shuttered at least 900 storefronts across North Carolina.”

Small-scale, short-term lending in North Carolina reminds Sanders of the work that earned Muhammad Yunus the 2006 Nobel Peace Prize. “He said the heart of his work at the Grameen Bank in Bangladesh involved ‘creation of opportunities for the majority of people — the poor,'” Sanders said. “High-cost, small-scale loans for the poor are a good thing. Not allowing those opportunities because some would misuse them is, in net effect, harmful to the very people it is supposed to help.”

Jon Sanders’ Spotlight report, “For Their Own Good: Ban on high-cost lending leaves poor consumers worse off, with fewer choices,” is available at the JLF website. For more information, please contact Sanders at (919) 828-3876 or [email protected]. To arrange an interview, contact Mitch Kokai at (919) 306-8736 or [email protected].