Borrowing trouble

State lawmakers are considering a bill to tighten the rules on payday loans, a costly form of short-term borrowing best suited for temporary cash-flow problems. But rather than trying to keep debt-laden consumers from compounding their woes, the measure (AB 377) would enable them to dig themselves a bigger hole by raising the maximum amount of a payday loan from $300 to $500. The combination of weak safeguards and higher loan limits poses an unacceptable risk, and lawmakers should either fix the measure or abandon it.

Payday loan companies act as small-scale lenders of last resort for people who have jobs and have checking accounts yet aren’t able to use less-expensive forms of credit. To receive a loan, borrowers write the lender a postdated check for the amount they want to borrow (plus a fee, which is typically 15% of the transaction). The lender cashes the check shortly after the borrower’s next payday, and the loan is closed. A $255 loan typically carries a $45 fee from a payday lender; if the same amount were charged to a credit card and paid off a month later, the cost would be about $4.

Supporters of the industry, which made $2.5 billion worth of loans in 2006, say it provides the kind of small, quick loans that banks generally don’t offer, often to low-income borrowers underserved by banks. And payday loans are a relative bargain compared with the cost of bouncing a check. The problem with these loans, though, is that they are too often used to respond to serious financial difficulties rather than pay an unexpected bill that lands at an inopportune time. On average, California borrowers who use payday loans take out seven a year, which suggests that a significant percentage of them depend on such loans to make ends meet. Critics also point to studies showing that payday borrowers are more likely to bounce checks, fall far behind on their credit card payments or file for bankruptcy than people who don’t take out such loans.

Payday loans may not lie at the root of these ills. Many of those borrowers were probably in a financial bind to begin with, which is why they sought the extra funds. Nevertheless, the loans can exacerbate the problems faced by people whose troubles stem from more than just temporary cash shortages. The state already bars lenders from issuing new loans to repay old ones, yet it doesn’t have an effective way of enforcing that restriction across multiple lenders. Until such a mechanism is in place -- as well as a limit on the number of payday loans an individual can obtain in a year, to guard against borrowers becoming dependent on the loans -- the Legislature should keep the $300 limit in place.