Payday Lending “Reform” in Ohio Will Just Dry Up These Needed Loans

COMMENTARY Markets and Finance

Payday Lending “Reform” in Ohio Will Just Dry Up These Needed Loans

May 15, 2018 3 min read

Former Director, Center for Data Analysis

Norbert Michel studied and wrote about financial markets and monetary policy, including the reform of Fannie Mae and Freddie Mac.
These developments do not bode well for Ohioans. traveler1116/Getty Images

For the last few years, Pew Charitable Trusts -- an advocacy group, not to be confused with the Pew Research Center -- has orchestrated a campaign to quash the payday lending industry. Their playbook closely aligns with that of the Center for Responsible Lending and the federal Consumer Financial Protection Bureau.

The approach is simple: Spread misleading information; scare everyone; and use the government to micromanage people's lives.

Just last month, Pew praised Ohio legislators for passing a new bill (House Bill 123) out of committee.

Pew called it "a long overdue step toward reforming the state's payday loan industry." But what the bill actually does is make it virtually impossible to make short-term loans.

How restrictive is the bill? It places arbitrary limits on the loan period, the dollar amount of loans, the interest rate charged on the loan, and the manner in which interest is calculated.

All of these mechanisms will make it extraordinarily difficult for millions of Ohioans to get what they clearly want: small loans to tide them over for a few weeks.

When Ohio legislates these loans out of existence, that demand will not disappear. People will have no choice but to resort to more costly and burdensome options.

Pew -- and partner organizations such as Ohioans for Payday Loan Reform -- attack these loans by characterizing lenders as predators that charge triple-digit interest rates to snare people in debt traps. Doubtless some bad actors exist, but the overwhelming majority of payday lenders - just like the majority of nonfinancial businesses - do not engage in fraud.

In particular, lenders do not actively seek out customers that cannot pay back their debts. Those who operate like that do not stay in business very long.

Academic research and all sorts of customer testimonials show that the typical payday loan customer is no fool. He knows exactly what kind of debt he's getting into and is perfectly willing and able to pay for it.

The Consumer Financial Protection Bureau's own complaint database supports this notion: Four years of raw (i.e., completely unverified) complaints total less than one tenth of 1 percent of the number of annual payday loan customers.

As for the supposedly high cost of these loans, critics misuse a specific financial concept: the annual percentage rate, or APR.

Ohioans for Payday Loan Reforms, for example, claims that, "Payday loans in Ohio are the most expensive in the nation, with an astounding typical annual percentage rate (APR) of 591%. These short-term, high-priced loans can trap hardworking Ohioans in a cycle of debt."

Advocacy groups misuse the APR concept in two related ways. First, they insist that all fees and charges - even non-interest charges - should be included in the APR calculation. (The Ohio House bill takes this approach.)

By this logic, bank overdraft fees should be run through an APR calculation, and anyone who overdraws their account by $1 would be susceptible to an APR of more than 1,000 percent.

Second, the APR represents the actual rate of interest someone pays over the course of a year due to compounding, the process whereby interest is added to unpaid principal. In a typical case, payday loan customers do not borrow for a full year, and the interest charges do not compound.

In other words, the APR is meaningless for a payday loan: A customer who pays $25 to borrow $100 for two weeks pays a fee at a rate of 25 percent.

Regardless, it is simply impossible for any third party to objectively state that lenders are charging consumers too much for their services. Policymakers should start with this assumption instead of trying to set arbitrary interest rate caps and time limits that prevent people from getting the credit they need.

On the national front, the Trump administration short-circuited the CFPB's fight against payday lenders thanks to Richard Cordray's decision to run for Ohio governor. But Governor Kasich has hired Zach Luck, one of Cordray's former senior advisors, and Ohio's ruling class appears to be taking the same adversarial approach to the industry.

These developments do not bode well for Ohioans.

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