The payday loan industry has engaged professional public relations lobbyists and commissioned social researchers to produce reports to play down the destruction caused to the lives of Australians who find themselves in a debt trap thanks to these insidious loans.
Why? Because they want to avoid stricter regulation, and because they want to continue to charge exorbitant fees and interest rates that can attract comparison interest rates between 407% and 112%.
(Comparison rate calculations completed using RiCalc software assuming maximum permitted fees and charges, and fortnightly repayments. 407.6% comparison rate calculated using a 30 day loan of $200 with total repayments of $248. 112.1% comparison rate calculated using a 12 month loan of $1,000 with total repayments of $1,680.)
Here are a few facts to take into account the next time someone tries to spin a story about how payday loans are meeting an “essential” need for Australians.
Myth 1: Payday loans are an essential and necessary feature of the consumer credit landscape.
The payday lending industry contends that there is an “irreducible need” for small amount short term credit in the community. Payday loans are necessary, they say, as the only product servicing that need.
This argument overlooks the fact that payday loans exist in only a handful of countries, and have only been available in Australia since the late 1990s.
Fourteen US states and the vast majority of developed European economies do not allow payday lending. If they don’t need them there, we don’t need them here.
Myth 2: Payday loans help get borrowers out of hardship
Payday lenders claim that payday loans are simply bridging finance that allows borrowers to overcome temporary shortfalls in their cash flow. Research from DFA Analytics and Monash University found that payday loans most commonly paid for basic living expenses including food, bills and car related expenses.
Claims that these loans help people get out of hardship ignore the fact that the cost of a payday loan is itself a significant financial burden for a person on a low income. You could say that a low income earner who is trapped in a debt cycle has effectively taken a pay-cut—courtesy of their payday lender.
A $300 payday loan typically requires a $372 repayment after 28 days. Given such a high repayment, it should be no surprise that a low income borrower will borrow again, to meet a further shortfall created by the cost of the loan itself.
This is how payday loans trap Australians into an ongoing debt cycle. Far from assisting them to overcome financial hardship, payday loans perpetuate hardship.
Research from DFA and Monash University finds that the number of borrowers taking multiple or recurrent loans has increased in recent years. The industry’s own research finds that around 25% of lenders provide payday loans to borrowers who have had two or more such loans in the previous 90 days.
Myth 3: If you prohibit payday loans, there will be an explosion in illegal lending
Payday lenders will claim that if payday lending is prohibited then illegal money lenders, or “loan sharks”, will fill the void.
This is an alarmist argument which falsely presumes that the prohibition of a service will naturally create a black market of equal size.
If this argument were true, then Germany and France would be over-run with loan sharks.
The fact is that no link has ever been shown anywhere in the world between interest rate caps and a related rise in illegal lending activity.
Myth 4: If you prohibit payday loans there will be an explosion in defaults and indebtedness
Payday lenders typically claim that payday loans act as a financial cushion, preventing Australians from defaulting on other payments and saving them from indebtedness.
This argument ignores that fact that by avoiding defaulting on one bill (say, a gas or power bill), we’re more likely to default on the next bill (say, a credit card bill, or rent)—due to the reduction in their income arising from the cost of their payday loan.
There are other hardship options available to Australians struggling to pay their bills that don’t involve racking up high interest debts. Many people feel embarrassed about asking for this sort of help, but it’s important to remember that all kinds of people find themselves in hardship for all sorts of reasons, and that visiting a payday lender can lead to more problems with their bills in the long term—requiring more embarrassing phone calls or worse.
Financial counselling agencies are seeing clients with financial issues caused, or made significantly worse, by the use of pay day loans. It is clear the use of these insidious loans is causing hardship because they impact people’s ability to manage their finances. That’s because the payday lender get the first cut of a person’s income.
Payday lenders ignore the fact that many Australians come to them because they have exhausted other lines of credit, and are not considered credit worthy by other lenders. Payday loans do not reduce indebtedness—they feed off it.
Myth 5: If you prohibit payday loans there will be an explosion in demand for social welfare
This argument is again based on the false premise that if it is prohibited, then payday lending will need to be replaced by equal funding from an alternative source. There are two things that can be said about this argument.
Firstly, a high proportion of payday loan borrowers—almost 25%, at last count—are Centrelink recipients. As such, many borrowers are committing a significant proportion of their welfare payment towards repaying payday loans.
Secondly, Centrelink payments don’t rise or fall on the basis of what other credit the consumer may be able to access. If a consumer is eligible for social security, then the pressure they place on the social welfare net will not increase in the absence of payday lending.
There is an argument that payday lending increases reliance on emergency relief as families struggle to manage loan repayments and need to turn to food packages and other emergency assistance.
Conversely, whether or not a consumer can access payday lending will not affect their eligibility for social welfare, or the likelihood that they will access it.
Myth 6: It’s not financially viable to lend small amounts, which is why interest rates have to be high
Without doubt, there is a gap in the market for smaller loans amounts that aren’t charged at exorbitant rates. Payday loans, however, are not an acceptable stop-gap to this market failure.
The viability of smaller loans was the subject of a pilot program by NAB. The pilot only looked at one segment of the fringe credit market—loans between $1,000 and $5,000 for a term of 12 months and found it was possible to ‘make a modest profit and be well below … interest rates of 48% per annum’. It also found that it was unlikely that loans for less than an average size of $700 over periods shorter than a year can be offered commercially at rates of interest at 48% per annum.
If a business can’t afford to sustain itself without charging unacceptably high levels of interest to Australians with the least ability to pay, they should exit the market.
Myth 7: It’s the amount to be repaid that’s important, not the interest rates
The idea that a ‘small’ amount is a better measure of the fairness of these loans fails to take into account that most payday loans are given to low income consumers, for whom a small amount may still be a huge impost—especially when a massive interest rate inflates the total cost to Australians. Typically, for every $100 borrowed for 30 days, $124 needs to be repaid. Compare this to a $100 cash advance on an 18% per annum credit card, where around $101.50 will be due after 30 days.
Very few people would consider a 200% interest rate to be a good deal—but people still take out payday loans at this rate because they have few other lines of credit. Payday lenders hide their high interest rates by promoting the amount to be repaid. Unlike other lenders, they’re not obliged to disclose an annual interest rate.
For people on small, fixed incomes, it can be incredibly difficult to budget for an additional sum that might appear small but actually represents such a high proportion of their income. It is not difficult to imagine how easy it is to fall into a pattern of repeat borrowing to cover a shortfall, which happens again. And again. And again.
Myth 8: Responsible lending requirements make a cap unnecessary
Responsible lending provisions mean that credit providers can’t provide credit products and services that are unsuitable for the consumer’s needs and that the consumer does not have the capacity to repay.
This relies on Australians providing complete and accurate information to the lender, and on lenders making an objective assessment of your genuine capacity to repay.
A report released by ASIC in March 2013 indicated compliance problems in the industry. ASIC found that some lenders’ files do not sufficiently demonstrate that payday loans are lent responsibly, including lending when the applicant is in default on another loan, or a loan has had multiple loans within 90 days.
Further, many small amount loans may be considered affordable when considered individually, but it is the cumulative impact of payday lending can lead to financial problems. A borrower who has fallen into a debt spiral and who obtains a payday loan every income period for months on end, is certainly experiencing harm at the hands of their lender.
Myth 9: People actively choose to use payday loans—and regulation shouldn’t interfere with their free choice
Choosing between going without food or paying the rent that is due immediately, or taking out a loan with a large amount of interest to avoid going hungry or being evicted, isn’t a wise or safe ‘choice’.
Competition on price doesn’t exist in the payday loan market because the cost of the credit is a very low consideration for the borrower.
People ‘choose’ their payday lender based on the convenience of the location, the friendliness of store staff, and the ease of getting a loan. And due to the high interest rates charged, many people quickly find themselves dependent on payday loans to get out of the debt spiral, caused by payday loans themselves.
So what can we do?
There are two ways to address this—through either addressing the broad issue of insufficient income of the people accessing these loans, or putting a limit on the excessive amounts of interest people are being charged.
In fact both will be necessary, while we have these products freely available.
A comprehensive cap on interest rates will allow Australians to access much safer products, without perpetuating the debt spiral.