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Sunday, September 10, 2006

Payday Loans and the Military

Members of the military take out payday loans "three times as often as civilians" and often end up in financial trouble:

On Payday, Many GIs Pay Back, by Annys Shin, Washington Post: Six months ago, John Elliott, a sailor based at Norfolk Naval Station, was having trouble keeping up with his bills, so he ... took out what's known as a payday loan, borrowing against future paychecks in exchange for money on the spot.

Elliott borrowed a total of $1,600 from four lenders, but the high fees he was charged each time he took out or renewed his loans made them hard to pay off. In another six months, his debt could balloon to as much as $4,480. "I thought I would pay it off in a couple of months," he said. "It's taken longer than I thought."

Elliott's experience of a short-term loan turning into a long-term liability is a familiar scenario to payday customers, many of whom live from paycheck to paycheck and have little access to other forms of credit. A Defense Department study published last month found that members of the military use payday loans three times as often as civilians.

To get a payday loan, all a borrower needs is a checking account and a pay stub. There is no credit check. The borrower simply hands over a post-dated check for the amount of the loan plus fees or gives the lender authorization to automatically withdraw money from a bank account.

But the fees can be high, averaging $15 to $30 for every $100 loaned. If a borrower does not pay back the loan by the next payday, the lender can deposit the check or take the money from the borrower's account. The borrower can also renew, or "roll over," the loan, incurring another round of fees. All told, such fees can add up to an annual percentage rate of 400 to 700 percent.

Though payday loans are supposed to be used for the occasional cash crunch, many customers repeatedly renew or "roll over" their loans. Studies ... found that payday customers renewed loans an average of 10 to 13 times in one year.

Consumer groups say the way the loans are structured makes it easy for low-income earners to get in over their heads. "These are loans made without regard to ability to pay to people who have trouble making ends meet," said Jean Ann Fox, director of consumer protection for the Consumer Federation of America.

Payday loans have caught the attention of Pentagon officials and members of Congress, who worry that the high fees contribute to financial problems among military personnel.

While it's bad enough for a civilian to fall deeply into debt, the consequences for members of the military can be far more severe, including the loss of security clearance or a court-martial. Those consequences make military personnel the perfect clients for payday lenders because they have extra incentive to pay back loans, Fox said. ...

In the Navy, security clearances are being revoked or denied for financial reasons at eight times the rate they were four years ago. The Pentagon has asked Congress to limit what payday and other lenders can charge active-duty military personnel to an annual percentage rate of 36 percent. The cap would include all fees.

The payday lending industry is fighting the cap, saying it would cut service members off from a much-needed source of credit and drive them to less regulated alternatives, such as offshore Internet lenders.

Department of Defense officials, however, feel the need to act, as payday lending storefronts have clustered near large military installations... What attracts payday lenders to bases, the Defense Department report said, are thousands of young, financially inexperienced service members who have bank accounts and steady jobs but little savings and, often, flawed credit. ...

Other than lack of information, which the military can solve by giving the needed information to military personnel, I don't see the market failure that requires government intervention (another solution is for the military to make the loans itself). Is there something stopping firms from entering this industry, competing with existing firms, and driving down interest and fees to the competitive level? I'm not endorsing these loans, but if there's no substantial market failure, what's the basis for the regulating these markets?

Update: Comments don't agree. Even the conservatives say I'm a cold-hearted free-marketeer, or something like that, on this issue...

    Posted by on Sunday, September 10, 2006 at 04:13 AM in Economics, Financial System, Market Failure, Regulation | Permalink  TrackBack (0)  Comments (15)

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