Nathan Fiala is an assistant professor at the University of Connecticut. He has worked closely with governments, international aid organizations and microfinance institutes across Africa.
Payday loans are intended to help people who want or need access to credit that banks are unwilling to provide. However, the difference between wanting credit and needing credit can be important. When high-interest credit is used for wants instead of needs, it can be a terrible idea.
Payday loans are essentially the United States version of microfinance: they have very short repayment periods, the interest rates are very high, and they target those who can’t access normal credit channels. Small-scale, high-interest-rate loans can lead people to remain impoverished when the additional debt they accrue becomes too burdensome — a problem that often occurs in the field of microfinance and, we have found, with payday loans. That’s not to say that short-term loans in the U.S. are always a bad idea. On the contrary, they fulfill a need. But what is that need, exactly?
In the United States, the most common need is to pay for emergency expenses. Forty-seven percent of Americans say they don’t have enough money saved to cover a small emergency. Unexpected medical bills, car repairs or a lower paycheck could mean a week without food. When family can’t help, to whom can people turn? Banks aren’t interested in small, temporary loans — they don’t make money that way. When the alternative is going without food or losing your car, payday loans are the least-bad solution.
But for almost every other conceivable case, they are a terrible idea. They are prohibitively expensive and, perhaps more importantly, behaviorally dangerous. When easy credit is not available, people think twice before making unnecessary purchases. Payday loans allow people to make non-critical purchases at high interest rates, which means they are paying even more for things they don’t really need.
Short-term, high-interest loans should be available only for truly urgent needs. In a perfect world, these loans would be prohibited when people are making clearly bad choices that have long-term negative consequences for them and their families. But how? Who’s to say what constitutes a family emergency or dire need? As Americans, we rely on our freedom to choose: It is up to the individual to make responsible choices.
What the U.S. truly needs are policies that ensure that low-income people don’t need payday loans to begin with. We need to end the problem of hunger that leads many to look to these loans to put food on their tables when money runs low. We need to continue to reduce the burden that medical coverage places on poor families.
Researchers have published countless articles on how to address these issues, but we don’t have a clear solution — if it was that easy to solve poverty, it would be over by now. That said, recent solutions do show promise: guaranteed minimum income programs and cash grant programs such as Prospera (formerly Oportunidades) from Mexico, which gives families direct cash payments in exchange for school attendance and health clinic visits.
Currently, much of the United States’ low-income support bureaucratically restricts individual choice. We need a system that gives options back to individuals and gives them the individual power to make good long-term choices for themselves and their families. Research shows that the poor don’t actually waste their money on drugs or alcohol when they receive cash programs. Instead, when given control over their own lives through policies that provide simple cash, such as Prospera, they make good choices. Sometimes it still means a high-interest short-term loan. But it’s far less often.
Payday loans aren’t the problem. Rather, they’re are a symptom of a larger epidemic. The only long-term solution is to eliminate the core problem of poverty in the United States.