Imagine, somewhere in the Inland Empire, a young couple with two children just getting by financially. One morning the husband’s car won’t start. If he doesn’t get to work, he’ll lose his job. But the next payday is nearly a week off and the family doesn’t have money for repairs.
At the same time, an older couple in the Bay Area is hit with an unexpected expense that nearly wiped out their checking and savings. They need cash today for groceries to last them until they’ll receive their monthly pension check in a week.
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How can these and many others like them across the state survive their financial emergencies? What are their options?
In some cases, they’re able go to family or friends. But not everyone can. For many, the best alternative is a short-term, small-dollar loan.
About 12 million Americans take out short-term, small-dollar loans each year, according to Pew Charitable Trusts. That shouldn’t be surprising. Many in this country live from paycheck to paycheck. This is especially true of Californians. After paying their living expenses, households here have only 7.58 percent of their income left over, the second lowest in the nation.
Despite their usefulness, Sacramento wants to regulate short-term, small-dollar lenders. Assembly Bill 539, which was approved by the Assembly just before the Memorial Day weekend, caps interest rates at 36 percent, plus the federal funds rate, on loans between $2,500 and $10,000. It also bars lenders from charging a penalty for prepayment “and establishes minimum loan terms.”
Should AB 539 become law, it would virtually shut down an industry. When the Obama administration considered cracking down on short-term, small-dollar lenders, it found that nothing more than a 30-day cooling-off period between loans would cause loan volume and revenues to decline between 60 percent and 82 percent.
The effects of AB 539 could be just as destructive, if not worse. That 36 percent interest rate ceiling is a de facto ban on short-term, small-dollar lending because loaning at a 36 percent rate in the short-term is a money-losing enterprise.
While a $100 two-week loan does generate revenue — a mere $1.38 — lenders can actually lose nearly $13 on the transaction. Business operating and other expenses add up to $13.89, says the Competitive Enterprise Institute (CEI), leaving the lender $12.51 in the red. The economics make it impossible to loan money at 36 percent in the short-term and stay in business.
Consequently, AB 539 would hurt the consumers it’s supposed to protect.
One, access to credit will be limited, and not only for those with emergency needs, but others who have poor or no credit histories.
Two, with more limited access to credit, some consumers will have no choice but to overdraw their bank accounts. One-third of consumers, says Pew Charitable Trusts, uses banks overdraft programs as a form of “costly, inefficient credit.” It’s an expensive tradeoff. Consumers pay nearly $35 billion a year in overdraft charges, far less than the $9 billion they spend a year on short-term, small-dollar loan fees.
There can also be legal costs for writing checks when there’s not enough money to cover them. Under California law, bounced checks can be prosecuted as felonies if the total exceeds $950.
The campaign against short-term, small-dollar lenders is being led by politicians, not customers who feel they were burned by the experience. Consumers actually value the services lenders offer: 95 percent say it should be their choice to take out the loans, according to a Harris Poll, 84 percent say it was easy for them to repay their loans, while 94 percent repaid their loans in the amount of time they had expected to.
As harmful as AB 539 would be for California, it would be worse if it were spread to the 34 states where short-term, small-dollar loans are still legal. Yet congressional Democrats in Washington, D.C. are looking at it as a national model. They’re also proposing a business-killing, consumer punishing 36 percent cap on loans.
Policymakers believe they must protect consumers from their own actions. But short-term, small-dollar loans provide an important lifeline to millions of consumers. It would be a disservice to take that away.
Kerry Jackson is a fellow with the Center for California Reform at the Pacific Research Institute.
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