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Reviewed by Joel Ohman
Founder, CFP® Joel Ohman

UPDATED: Jan 24, 2013

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The war on payday lenders wages on.

Across the country, legislators and politicians fight to end payday loans once and for all. In addition, there are other voices emerging from those who believe in a right for financial choice and freedom.

But are their insights educated or simply biased?

Support in an Unlikely Realm

Although there are few non-business advocates for payday loans, one collegiate professor does see a need for short-term lenders within the economy.

The article “The Pitfalls of Regulating Consumer Credit” defends the high-criticized payday loans because of their impact on unbanked citizens.

The publication, co-written by Todd Zywicki, Professor of Law at George Mason University School of Law, and Robert Sarvis, an MA Student in the Department of Economics at George Mason University, states that “payday loans…may legitimately be the most attractive option, due to their convenience, reliability, and availability on short notice.”

Zywicki and Sarvis commend the loans because of their ability to fill a void in the economy.

“Payday loans therefore fill an important gap in the supply of financial services to the poor,” according to the publication. “Payday lending offices may provide the only source of short-term credit available to residents of neighborhoods lacking traditional bank branches.”

The article states that due to poor previous credit decisions, some borrowers are unable to access any other form of legitimate credit. For borrowers that can access necessary cash with payday loans, it can be a relief.

“As a result, these consumers often value the simplicity and pricing-transparency of alter-native credit productions,” according to the publication.

Current Legislative Law

But not everyone is as keen on having this sometimes-volatile financial option.

In a recent press release, U.S. Senator Richard Blumenthal (D-Conn) requested immediate action to stop or limit bank payday loans. In conjunction with four other U.S. Senators including Sherrod Brown, Richard Durbin, Charles Schumer, and Tom Udall, Blumenthal requested federal regulators to step in and halt “predatory” payday loans.

Currently, bank payday loans are illegal in 14 U.S. states.

Four of the country’s major banks have begun to offer loans with similar characteristics to non-bank payday loans. These banks include Regions Bank “Ready Advance,” Wells Fargo “Direct Deposit Advance,” Fifth Third “Early Access,” and US Bank “Checking Account Advance.”

According to Blumenthal’s release, the typical bank payday borrower will take out 16 payday loans throughout the year. Some borrowers take out as many as 20 to 30 loans in one year.

The potential need for multiple payday loans can spiral into debt due to the significant percentage charge for the short-term loans. For bank customers with direct deposit, banks will advance the customer’s pay for a fee, ranging between $7.50 and $10 for every $100 borrowed.

Sometimes it is not a matter of the end cost, but rather whether or not consumers know the cost before getting a payday loan.

In Blumenthal’s release, he writes that payday loans are “products designed to trap low-income consumers in a cycle of debt.”

But Zywicki and Sarvis question why they should be eradicated for those who properly use them. The publication states that a consumer’s desire and need for credit should not be ignored since there are many consumers who use these methods properly.

“Politicians and bureaucrats need to understand the important and legitimate [sic] roles various forms of consumers credit play in the financial lives of consumers, both poor and non-poor, and to acknowledge the appropriate [sic] role that fees, interest rates, and other terms of credit play in regulating its availability,” the publication states.

Hurting or Helping the Underserved?

The tireless work by legislators to restrict bank payday lenders is questioned by Zywicki and Sarvis.

For some consumers, the outcome of legislator’s assistance is not as initially expected. The authors write that the actions by regulators are “well-intentioned but misguided.”

“Legislators and regulators assume that restricting particular forms of credit will lead to fewer bad financial outcomes. But this…can lead to worse, not better, outcomes,” stated the publication.

According to the report, nine million households do not have a traditional bank account. Limiting the financial options for those consumers could have an impact on the economy.

If banks and lending institutions can no longer offer payday loans, they will simply move to another lending realm. Future revenue increases could be seen in ATM withdrawal fees and checking accounts. And as the cost of checking accounts increases, some families simply cannot afford to have an account any longer.

“Well-meaning limitations on banks’ credit-financing fees can actually increase the number of unbanked households,” the report said.

Questionable Source of Funding

Kathleen Day, media relations at the Center for Responsible Lending, said the study by the Mercatus Center is what the payday lending industry wants.

“They always are saying the same thing,” Day told

The Mercatus Center at George Mason University, the organization that financially supported part of Zywicki’s report, is a think tank affiliated with the Koch family, who owns the majority of Koch Industries, an oil, gas and chemical conglomerate.

Zywicki confirmed that he received support from the Mercatus Center, but is unsure of where the financing comes from. He said he is not involved in their fundraising.

And this is not the first time that Zywicki has fought against restricting the payday lending industry.

Day believes the current study by Zywicki and Sarvis lacks any real evidence. She said the threat of increasing underwriting and limiting credit does not make it scarcer, as shown through the Credit CARD Act of 2009. The Act put limitations on the credit card industry, but Day said that although industry professionals were worried about it limiting consumer credit, it didn’t.

She said it made the rules “more transparent.”

The same fear is sweeping the payday lending industry: a fear that regulation will hurt consumers’ ability to access credit. And when payday lenders say that limiting payday loans will hurt consumers, Day has a rebuttal.

“My simple question is: give us an example. And there’s haven’t been any,” she said.

Alternative Funding Options

Day said consumers are better off using credit cards, even with interests of upwards of 20 to 30 percent.

She said the APR for a payday loan is typically close to 400 percent, and for a person in a financial bind, it leaves them without a way to pay for necessities like rent and food.

She said for a payday loan ranging between $300-350, the average borrower will repay back $800. The majority of the repayment is for interest.

“It is really a backbreaking thing,” she said.

But more than the cost of interest rates, Day is more concerned about a lack of regulation and underwriting. She said “it’s amazing” that legislation has to be passed for situations where people cannot repay their debts.

Day referenced the mortgage crisis as an example of what could happen if the payday industry isn’t regulated.

“The lack of underwriting is really what caused the mortgage meltdown,” she said.

Unlike current mortgage and auto loans laws, the payday industry does not ensure that a borrower can legitimately repay their loans before they are given.

But Zywicki said that lenders already have incentives to confirm that they are underwriting loans responsibly. He said that borrowers pose a financial risk to the lenders.

“The interest rate is higher because the risk is higher,” he told “The borrowers are inherently risky.”

Zywicki said that some regulations improve consumer choices, such as the Truth in Lending Act, but not all regulation is positive.

“Regulation always has unintended consequences,” he said. “We get in trouble when we replace consumers judgment about what products are best for them…Consumers are aware of which option is best for them at any given time.”

He continued stating that the reason that consumers use payday loans is due to a lack of options, not because they are unaware of the cost. Zywicki said that consumers turn to payday loans because it is “the best option that they have at any given time,” and without them, they are forced to turn to loans sharks and pawn shops.

For some payday users, they have nowhere else to turn after a failure to gain approval on credit cards, or after maxing out their maximum balances.

But even though the APR for payday loans reaches into three digits, Zywicki does not think this option should be taken away. He said that “evidence is overwhelming” that consumers know the actual cost of a payday loan.

“Taking away choices from people who already have limited choices is not going to make them better off,” he said. “You can’t wish away the need of consumers for credit.”

Zywicki told that he has “not personally” taken out a payday loan.

Who Controls Regulation?

Part of the fight between supporters and enemies of payday loans deals with whose right it is to regulate the industry.

According to Zywicki, the payday loan industry has enough credit reporting systems in place to track current and potential customers. He said that any formal regulations on payday loans should be “up to the industry.”

He continued stating that any further credit checks would make the products less effective and more expensive for the consumers that rely on them.

“Consumer credit provides a very, very important benefit to consumers, small businesses and the economy,” he said. “We need to be very careful in regulating in such a manner.”

Day agrees with Zywicki in the importance of credit, but disagrees that regulation will hurt it.

“Credit is credit. It can be good or bad. It is essential to a functioning economy,” she said.

Day said she teaches entire classes about credit, so summing its worth in a simple sentence is difficult, but she does believe that unregulated credit can have a hugely negative effect on consumers.

“Credit done without underwriting, as we have seen [in the mortgage industry] can cause great harm to the economy,” she said.

Can the Sides Ever Agree?

In the end, both sides fight for their version of logic.

Defenders of payday loans say it is illogical to steal away citizen’s right for a need or credit.

“We need to be careful about taking away products because we don’t like the choices that consumers make,” Zywicki said.

Others realize that credit is not a right, but rather a useful tool for those strong enough to handle the responsibility.

“We have evidence that making a loan to someone who is in financial difficulty, in terms they can’t afford to repay, makes no sense,” Day said.