Opinion | I’m an economist and I support payday loans

Gary Wolfram, an economics professor at Hillsdale College

Gary Wolfram is the William Simon Professor of Economics and Public Policy and Director of Economics at Hillsdale College.

A recent article in Bridge Magazine told the stories of people who got in over their heads using payday loans and needed to be rescued from the debt cycle that ensued. Stories like these incite many to condemn the companies that sell these products ‒ in fact, legislation has been introduced in Michigan to further restrict access to these types of loans. 

The Legislature should tread carefully, however. For despite these anecdotes, payday loans and other similar financial products serve a valuable purpose for many Michiganders.

Related: Payday blues: Rural Michigan and the quick-cash debt hole

It’s easy to see why payday loans get such a bad rap. Most people have borrowed money for a home, a car or college tuition but the long-term loans offered by conventional lenders charge relatively low annual fees and interest rates. 

Comparing their rates with what’s charged for payday loans makes the latter look like a rip-off: The annual percentage rate of a payday loan can be more than 400 percent. But assessing short-term loans with the measures used to evaluate mortgages and car loans is misleading and inappropriate.

Panning payday loans for having a high APR is ill-considered. The money is borrowed only for a short period — a couple of weeks, typically — so figuring out what you would hypothetically pay for a year’s interest is practically meaningless. What matters most is the total amount the loan costs the consumer.

Instead of depending on an APR, short-term lenders typically charge a fixed price for borrowing a certain amount of money. One might still complain that these prices are too high. For instance, it might cost $60 just to borrow $500. That seems like a bad deal that no one should take. And yet, the Center for Financial Services estimates that about 15 million Americans borrow money under similar terms.

The truth is that borrowing money in this way can sometimes make financial sense. For example, what if you needed to pay a $200 cell phone bill tomorrow and would be charged $75 if the payment was late? Paying $60 to borrow $500 would leave you $15 better off than you would have been. An estimated 80 percent of Americans live paycheck-to-paycheck, so it’s not hard to imagine how millions of people could find themselves in a similar situation.

Consumers of payday loans are often stuck between a rock and a hard place. It’s not as if they were hoodwinked into choosing a payday loan over a relatively low-cost, long-term loan from a conventional bank. Instead, consumers of payday loans are often what the Federal Deposit Insurance Corporation calls “unbanked” or “underbanked,” and they make up about a quarter of American households. 

These consumers typically don’t have bank accounts and would not qualify for loans offered by conventional lenders. It’s likely that payday loan companies are the only ones willing to lend them money. In other words, for most customers, it’s either a payday loan or nothing.

Payday companies charge relatively high fees to lend money to this population because they face higher risks for doing so. The unbanked and underbanked are much more likely to default on loans, so lenders must charge these fees to help recoup the costs they incur when they lend money that is not repaid. This is the price of lending to a risky population ‒ something conventional lenders cannot or will not do.

It’s always unfortunate when someone unwittingly gets themselves into financial difficulties, as the stories in Bridge demonstrate. But it doesn’t follow that severely restricting access to payday loans will fix anything. After all, more affluent individuals also regularly get in over their heads with conventional loans. Should we restrict access to those too? 

The reality is that payday loans serve a needed purpose for millions of Americans. The only way to help people avoid fiscal difficulties is to do the hard work of educating them on how to be good financial consumers.

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Michael B.
Wed, 07/17/2019 - 8:45am

"Payday companies charge relatively high fees to lend money to this population because they..." are predators. Bring back Postal Banking and the PayDay Lenders will no longer be in business.

Wed, 07/17/2019 - 8:47am

Hillsdale prof..............Hmmmmmm........supporting predatory loans to poor people. Why am I not surprised.

Thu, 07/18/2019 - 12:28am

Funny, I was just about to say the same thing. All I had to see was the name of his institution and I knew what he'd have to say.

Fri, 07/19/2019 - 8:00am

You beat me to it.

Wed, 07/17/2019 - 8:58am

I wonder if Mr. Wolfram has a vested interest in a payday loan company. I find it interesting that a "professor" who does not appear to have knowledge of the "reality" of the everyday lives of people who need to access these type of loans would write this type of article supporting predatory lending practices.

I wonder how often Mr. Wolfram has been in a position of taking out such a loan? Sure let the "free market" work, no matter what effect it has on the poor. I would suggest Mr. Wolfram spend a year with someone who has a need to do this type of borrowing and understand the impact from a personal perspective.

Wed, 07/17/2019 - 4:30pm

The fact that he is at Hillsdale says it all.

Gary Lea
Wed, 07/17/2019 - 9:10am

I'd rather ask family members, friends or co-workers for a 'loan' than some payday company. Earning a bad reputation among those closest to me certainly implies a need to change habits. Perhaps laws should be enacted to protect oneself from one's own financial frivolity rather than protect predatorial practices.

Wed, 07/17/2019 - 9:10am

The cards are stacked against the borrower. Banks are currently paying between 0.01 and 0.1% interest on savings accounts although there are places that pay a bit more. Check out what it costs to borrow. The really big profits come from late charges and failure to pay off credit card bills in full each month. So in this context, a 400% interest rate can seem reasonable. Otherwise, not so much.

Eric A Schertzing
Wed, 07/17/2019 - 9:14am

I very much appreciate Bridge Magazine and other media outlets like the Wall Street Journal that give me a diverse set of opinions. Dr. Wolfram would be better referred to as a Libertarian political economist. That anything approaching 400% interest rates is good for someone is folly. As a county treasurer I have thousands of examples every year that prove to me hardly anyone is made better off from our forfeiture fees that frequently hit 25% per year. Wolfram advances a radical pure capitalism theory that is not supported by the real world.

John Q. Public
Wed, 07/17/2019 - 7:29pm

Then there's the other side of the coin: land bank authorities run by county treasurers like you. The legislature creates barriers to private competition and five-year property tax kickbacks on behalf of government agencies, and then they and land bank authorities use those statutorily mandated competitive advantages as justification for why government programs work and private markets fail in the rehab of foreclosed properties.

Margaret Leary
Wed, 07/17/2019 - 9:17am

Prof. Wolfram did not respond to the main point in the previous piece in BRIDGE. The “restricting access” this piece argues against is better characterized as “limiting the interest rate that can be charged” as do 12 states.
And, the core problem is the increasing wealth gap which makes it difficult for many people to earn a decent living.
The previous piece in BRIDGE also made the point that payday lenders earn huge profits; they do not, as this piece claims, need to charge so much in order to make up for loans that are not repaid. And they are not Michigan, or even U.S.-based companies.
It is unsettling that our legislature will not even discuss this issue, as the previous piece pointed out.

Wed, 07/17/2019 - 9:17am

What the title should read: "I'm a Hillsdale College professor and I support payday loans because it's poor people's own fault that they're poor"

Wed, 07/17/2019 - 10:27am

I used to work for a guy in Lansing who opened several check cashing facilities. (He is now deceased, this was about 19 years ago.) He told me that he studied them before he opened his first and the data then showed that if someone came in for one loan, they were good for about 4 pay cycles before they could be done with it and pay off the loan. He also told me he was amazed at the interest rate that it was legal to charge. He said, "This is like printing money." Wonder what kind of research the prof did?

Steven Zimberg
Wed, 07/17/2019 - 11:18am

Usurious payday loan interest rates should not be allowed in the United States except for accredited millionaire investors who truly understand the risks and whose lifestyle will not be materially affected by a total loss. This includes usurious credit cards. The cost to our society far outweighs the temporary fix that goes wrong. In the Professor Wolfram should look at the longer term affects of this issue and show where a new lending market has come along in the past decade to fill in the wide gap.

Geoffrey Owen
Wed, 07/17/2019 - 12:54pm

Seriously? If you need the first loan you will need to pay it and then take another until the the day when there is nothing left of the paycheck. This is truly a corporate welfare state we live in. No cash register to collect from the haves and no way to break even for the have nots. Thank God that Hillsdale College is too small to have an impact on our youth.

Paul Jordan
Wed, 07/17/2019 - 1:21pm

It should shock nobody that an economist from Hillsdale College supports such an exploitive industry. It is an EXTREMELY and regressively conservative institution. It is a bastion of extreme, ultra-capitalistic values.
Until the hyperinflation of the late 1970s--before neoliberal economists gained firm control of the economy--such interest rates were totally illegal. The payday loan industry is a great example of how corruption has come to permeate American life over the past 40 years. The great scandal now is not what is illegal, it is what is totally immoral--but perfectly legal.

mary therese lemanek
Wed, 07/17/2019 - 1:53pm

The spin that Prof. Wolfram has put on this topic is is dizzying and more than a little judgmental. Life does not follow the textbook rules of economics regardless of how responsible people try to be. Pay day loans provide a shovel for people to dig themselves further into debt...there are other options.

Thu, 07/18/2019 - 10:07am

What other options?

Christine Temple
Wed, 07/17/2019 - 1:55pm

Hillsdale. Republican. Nothing more needs to be said. His remarks "opinions" should be taken with a large shaker of salt.

Wed, 07/17/2019 - 3:29pm

"The only way to help people avoid fiscal difficulties is to do the hard work of educating them on how to be good financial consumers."

Okay... so what's the plan for that?

This "solution" reminds me of other simplistic answers to complex problems. The addiction problems in America weren't solved by telling people "Just say no to drugs." Unplanned pregnancy and STDs weren't eradicated by abstinence-only sex education. Immigration problems weren't fixed by telling people "just stop coming here."

It would be easier to take this professor seriously if he offered a real solution instead of just jumping to the defense of those getting rich by exploiting the poor. Saying "some unspecified party needs to utilize non-existent resources to teach poor people how to have enough money" isn't actually a plan.

Wed, 07/17/2019 - 3:45pm

Let's see.....grifting is good. Imagine Michael Douglas with his super greasy slicked back hair do in Wall Street exchanging "grifting" for "greed." I wouldn't let my cats go to Hillsdale. They should be embarrassed to have this moron teaching young people this perverted outlaw view of economics.

Wed, 07/17/2019 - 4:29pm

Hillsdale prof. Pretty much says it all. Not surprised.

Wed, 07/17/2019 - 4:44pm

Gary Wolfram Wolfram seems completely out of touch with reality, and possibility of alternatives.

The concept of "unbanked" and "underbanked" is literally made up. We create these rules and standards that are unattainable for 1/4 of U.S Americans. Then, because they can't get access to traditional (exploitative and extractive) banks, they are forced to use payday lending. Payday lending is the last resort, and it is designed to be profitable.

This system of exploitation is created. Payday lending is predatory. This product is designed to be predatory. It is expensive to be poor, and there is money to be made by exploiting the poor. There are alternatives. Payday lending does not need to be exploitive, it is exploitive because it is profitable.

However, there are alternatives. 0 interest lending, and non-extractive lending is possible and necessary.

One example of people working towards alternatives is The Village Financial Trust in Minneapolis. VFT has created a program called New Day Loans. "The creation of the Village Financial Loan Fund allows us to offer consumer loans (ie. alternative to payday loans and check cashing services) to residents of North Minneapolis. We see this as a two-fold approach; disrupt the predatory lending that exists currently, and build a cooperative membership base by meeting the immediate financial needs of community members. We see this as a important part of building economic democracy and a cooperative economy for low-income and communities of color in Minneapolis."

It is absolutely possible to provide zero interest or very low fees for loans. Across the country numerous organizations have proven that this type of lending is possible, from Kiva, to non-extracitve lending by The Working World. Why non non-extractive lending for individuals? Sadly, we have philanthropists who prefer to give to the white-nonprofit industrial complex and we have a capitalist economy who has normalized high interests and high fees.

But alternatives are possible. This op-ed is infuriating because ti choses to justify the status quo rather than explore WHY this is the case, and what we can do to build a better and more ethical and just alternative.

John Q. Public
Wed, 07/17/2019 - 7:23pm

I don't dismiss Dr. Wolfram's treatise just because he is employed by Hillsdale College, or that he might be a Libertarian. The first question to me is whether government policy ought to be guided by a philosophy of "If we don't allow them to have bad luck, why, they'd have no luck at all!"

The second question in my mind isn't whether a consumer is better off paying a $60 lender fee than a $75 late fee on a $200 invoice; it's why we should allow companies to charge $75 late fees on $200 invoices. Many companies get to do that by getting state-sponsored barriers to entry by competitors, leaving consumers with a choice not among multiple providers, but between having a service or not. See, e.g., local oligopolies or monopolies on cable TV or ISPs.

I guess I wouldn't be against companies charging high fees for risky ventures if we allowed the free markets to operate freely. We don't, though. When they fail, they use their political connections to get more favorable terms, or worse, bailouts.

Thu, 07/18/2019 - 8:29am

Interesting example of the nation's problems and a sad picture of Bridge readers comprehension abilities. No where does Prof Wolfram say that payday loans are a great thing and that everyone should use them. His main point in this piece was that sometimes the cost of the loan is less than the expense the debtor seeks to avoid by taking the loan. People can and do weigh the costs in front of them and make decisions accordingly. And that small unsecured loans such as these have a very different set of economics. Again manifestly true statements. No where does he deny that other alternatives may be better IF available. Nor that some people put them selves in a bad spot through their over use. But by taking options away some people will face even bigger costs. (I've seen this in my own business.) So what do we get from Bridge readers on this? Nothing but a bunch of straw men and snotty ad hominem, off topic crap directed at Hillsdale College. I always though Bridge had a little more reasoned intellectual readership, clearly not.

Kelly Ripken
Thu, 07/18/2019 - 9:08am

"Hillsdale College Economist" is an oxymoron if I ever heard one. Like "humane slaughter" or "true lies." Try: "Ideologue with thick glasses and a title."

Tom S
Thu, 07/18/2019 - 4:45pm

Two things.

1: The following passage is simply factually wrong:
"Instead, consumers of payday loans are often what the Federal Deposit Insurance Corporation calls “unbanked” or “underbanked,” and they make up about a quarter of American households. These consumers typically don’t have bank accounts and would not qualify for loans offered by conventional lenders. It’s likely that payday loan companies are the only ones willing to lend them money. In other words, for most customers, it’s either a payday loan or nothing."
Virtually ALL payday loan consumers must have a bank account; the loan works by giving the lender a postdated check--e.g. direct access to your account, which they access on your next payday. I agree, however, that the mainstream financial system has failed them by providing none of the small, low-interest loans that used to be available prior to the 1970s.

2. The prices are quite high, and more importantly, states that have put in place price caps have seen payday loan fees and interest rates plunge without significantly restricting access to credit. See: https://www.pewtrusts.org/~/media/legacy/uploadedfiles/pcs/content-level...

Amber Paxton
Fri, 07/19/2019 - 2:22pm

"Instead, consumers of payday loans are often what the Federal Deposit Insurance Corporation calls “unbanked” or “underbanked,” and they make up about a quarter of American households. "

You have to present a post-dated check to receive a payday loan. This is why it is called deferred presentment. How exactly are unbanked persons doing that?

The simple fact of the matter is that almost everyone who utilizes payday lending is in a financial crisis. When that crisis is still in force two weeks later, and the loan can't be paid, the crisis gets worse. What we need is safe, affordable, non-predatory short-term lending products. Protecting predatory practices (and those who profit from them) because of a (solvable) lack of viable solutions helps no one.

Mike N.
Fri, 07/26/2019 - 1:57pm

It serves a need. There is definite demand.
People have complained for a decade, but the demand is just as strong.
Like anything where money is involved, there' a few bad apple lenders doing rollovers.
Which technically, are permitted, but up to a maximum. Varies per state.
But no one has stepped forward with a viable alternative.
There are alternatives, but most require credit checks.
Users of payday loans wouldn't qualify. Most have bad credit, or none at all. The unbanked.
A main reason fees are high with payday loans is the high default rate.
Probably why big banks won't touch them. About 5x.