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 consumers who find themselves in a debt traps thanks to these insidious loans.
Why? To avoid stricter regulation, and enable them to continue to charge exorbitant interest rates that usually range between 300% and 1000% (annualised percentage rate) to the most marginalised and vulnerable Australian consumers.
Here are a few facts to take into account the next time someone tries to spin a story about how payday loans ‘fulfil’ a consumer ‘need’.
o 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 for just over a decade.
The vast majority of developed European economies do not allow payday lending, and they aren’t a necessary feature of the consumer credit landscape.
o 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. Consumer Action’s research found that payday loans most commonly paid for basic living expenses including food, 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, a low income earner who is trapped in a debt cycle has effectively taken a pay-cut – courtesy of their payday lender.
If a $300 payday loan typically requires a $405 repayment, then 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.
In this manner, payday loans trap consumers into an ongoing debt cycle. Far from assisting consumers to overcome financial hardship, payday loans perpetuate hardship.
Evidence from the United States suggests that the majority of payday lending business is generated by repeat customers who are locked in a debt trap, and Consumer Action’s network of financial counselors and casework confirms this is the case.
Cash Converters, Australia’s largest payday lender, has publicly stated that its payday lending business benefits greatly from repeat customers.
o 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. For that matter, so would New South Wales, Queensland and the ACT.
The fact is no link has ever been a shown, in a jurisdiction anywhere in the world, between interest rate caps and a related rise in illegal lending activity.
o 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 consumers 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), consumers are 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 consumers 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 bill problems in the long term – requiring more embarrassing phone calls or worse.
Financial counseling agencies are seeing clients with financial issues caused 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, due to the fact payday loans get the first cut of a person’s income and the amount they are paying back for the loan itself.
In terms of indebtedness – payday lenders ignore the fact that many consumers 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.
o 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 40%, at last count – are Centrelink recipients already. 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.
In the case of emergency relief, 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.
o 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 the 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 ‘break even’ under a 48% cap- but recommended that further research was needed to ascertain if this was possible for the smaller amounts typically loaned by payday lenders.
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.
o 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 the consumer. Typically, for every $100 borrowed, around $135 needs to be repaid.
Very few people with any financial nous would consider a 600% 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 avoid people realising how high interest rates are by promoting the amount to be repaid and hiding interest rates until the customer signs the contract.
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.
o Myth 8: New Responsible lending requirements make a cap unnecessary
New 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 consumers providing accurate information to the lender, and on lenders making an objective assessment of the consumers genuine capacity to repay.
In the fringe credit market, consumers are desperate for finance, and lenders know that the vast majority of borrowing is from an uncreditworthy purpose.
Both sides of the transaction have an interest in evading the intent of responsible lending provisions. The notion that responsible lending provisions will operate effectively in such an environment is unlikely.
Although each instance of payday lending may not in itself offend responsible lending provisions (it is difficult to argue that lending anyone $300 at any one time, even on onerous terms, will fall foul of responsible lending provisions), the cumulative impact of payday lending is far from responsible.
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.
o 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, does not constitute an acceptable ‘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.
There are two ways to minimise the detriment suffered by payday loan customers – through either addressing the broad issue of insufficient income of the people accessing these loans, or putting a limit on the excessive amounts people of interest people are being charged.
A comprehensive cap on interest rates will allow consumers to access much safer products, without perpetuating the debt spiral that so many vulnerable consumers fall into due to unconscionable interest rates.
