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NY Fed Blog Questions Objections Raised on Rollover Limits

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The New York Fed website recently published a blog post that has questioned some commonly raised objections about payday lending and its rollover limits. Here, the author questions many critiques of these small-dollar loans, concluding by saying that more research must be carried out before we can convincingly say that the payday lending industry needs to be strictly regimented. We should be careful about rolling “wholesale reforms”, the blogger says. The post is titled “Re-framing the Debate about Payday Lending“.

This post in the New York Fed, has been written by Ronald J. Mann, Robert DeYoung, Michael R. Strain, and Donald P. Morgan. They all have high credentials, and thus, their findings are being deemed extremely valuable.

Mann is a Professor of Law at the Columbia University. DeYoung works as a Professor in Financial Institutions and Markets at the University of Kansas’ School of Business. Morgan is an Assistant Vice President in the New York Fed’s Research and Statistics Group. Formerly with the NY Fed, Strain is now the Deputy Director of Economic Policy Studies. He is also the resident scholar at the American Enterprise Institute.

With such high credentials, these four surely knows what they are talking about. On the other hand, many critiques of payday lending don’t have subject matter expertise. Often, many of them are not even economists or from the finance domain. However still, our lawmakers are being influenced by these people. There seems to be a complete lack of understanding of the realities.

What the Authors Said in the Blog Post

The four experts carried out an extensive study, and at the end, they are asserting that complains about payday loan companies charging excessive fees are unfounded. Further, they have said that these businesses don’t target minorities, which is another common complain. These charges do not hold up after a close scrutiny. So these charges cannot be valid reasons for objection.

What They Say About Fees

The authors have agreed to studies carried out previously where it was mentioned that the payday lending fees are actually very competitive. In fact, these four have even said that the competition is limiting the profits of these payday loan businesses. In other words, the lenders aren’t really profiting a lot, as has been said often by those who are always criticizing payday lending. The authors, in their report, have cited studies that discovered that risk-adjusted returns of payday loan companies are about the same as other financial businesses.

In fact, a study carried out by the FDIC with store-level data collected from payday loan companies discovered that the high APRs are justified because of the loan loss rate and operating costs.

And are these fees really all that high? A study done by “Which?” doesn’t seem to believe so. This consumer group found that the high street bank overdraft can actually cost more than payday loans. This of course isn’t the only report that has pointed this out. So if this short-term advance industry has to be regulated, then regulations should be imposed on the mainstream credit industry too.

The 36% Cap

Some consumer groups have said that there should be a 36% cap on the payday business. Authors of this blog don’t agree with this point of view. That’s because, payday loan companies are almost sure to lose money if this cap is applied. As evidence, they point out that there is no payday lending business in the states that have already implemented this 36% cap. So the four writers are completely against this cap, and have asked its advocates to “reconsider their position”. But there are certain elements in the country that want the payday loan business to go completely, though millions of Americans take cash advances from them.

Another report brought out by the Charles River Associates for the Community Financial Services Association of America revealed that strict action against payday lending will make the payday lending revenues fall by a staggering 82%. As a result, there is a high chance that many of these businesses won’t survive any more.

Five out of six lenders might go out of business.
The rural areas are likely to be affected the most.
Profits are expected to decline by an average of 68%.

What the Authors Said About Minorities

There is an outrageous charge against payday lending. It is sometimes said that these companies target people from specific racial compositions.

The four authors haven’t found any evidence of this after their extensive scrutiny. Payday lenders determine their target group based on financial status. As evidence, the authors have cited a study using zip code-level data.

It was revealed in the study that the racial composition of the zip area had no influence on the location of payday lenders. Individual-level data further revealed that Hispanic and African American people aren’t really more likely to take these loans as compared to others facing similar financial problems. This is just a myth.

On Rollovers

Some borrowers have a tendency to roll over their loans. Commenting on their blog post, the authors have blamed payday lenders that allow this, saying that this can easily lead to long-term debt that gets impossible to solve. However, we don’t understand the reasons for such roll over requests yet. It could be a behavioral issue. Also, there are some who will do a roll over intentionally, as evidence shows that borrowers who roll over often experience more positive credit score changes than those with fewer rollovers.

So we are still not sure why people ask for a roll over. Research to understand the reason has only just started. It is essential that we understand the causes and consequences of roll over before bringing about wholesale reforms.

Professor Jennifer L. Priestley even says that frequent roll over might not adversely affect the consumer. He has cast a serious doubt on capping them.

Some states have limited roll over already. So these states can be the “laboratory” that can help us find out how the borrowers there have fared as compared to the states where there are no rollover limits. Limiting roll over might be good for those with behavioral problems, but we must also know what is the cost to those who expect to roll over but cannot because of the cap. This we think will be an interesting study.

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