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The Worst Interest Rate in the World

This is a slightly modified version of something I wrote for my old blog in 2005.

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Payday loans work like this:

Let's say Joe is short $100 and has maxed out his credit cards. Joe goes to a payday lender. The lender gives Joe the money, and Joe writes a check for $100 plus a surcharge of, say, $15, dated two weeks in the future. Between now and two weeks, Joe gets his next paycheck, and the loan is covered.

But what happens if Joe's next paycheck doesn't cover the loan? What if the reason he is short is because his job doesn't pay him enough to quite make ends meet? Then, two weeks from now, Joe may have to borrow another $100 and write another $115 check, just to cover the check he wrote today. If this keeps up, by the end of the year Joe will have paid nearly $400 interest for a $100 loan. That's an interest rate of nearl 400 percent, enough to make credit card companies look downright generous.

In the wealthiest nation in the history of the world, payday loans are the only option for many low wage earners to guarantee that the bills can always be paid. But they are also a trap: If a poor person takes a payday loan, the interest may be enough to prevent the next paycheck from covering the bills, thus he or she needs to take another payday loan. The cycle can be endless.

Several solutions come to mind.

We could guarantee that the minimum wage is a living wage: Take the poverty line for a family of three, say, and calculate what a person would have to earn at 40 hours a week to meet that income level. That would become the new minimum wage. Recalculate annually.  But this will not happen with the current Congress and President.

States could set a maximum allowable interest rate for nontraditional lenders. But even setting it at credit card rates—around 20% annual—would drop the two-week fee low enough that payday loans would not be worth the lenders' time, and recipients wouldn't have this source of temporary cash.

But here's an entirely different sort of idea, derived from the concept of microlending. Suppose a nonprofit agency—perhaps a church ministry—offered payday loans at 0% interest? There would have to be safeguards to prevent people from abusing the system. There would have to be a limit to the amount a person could borrow. Recipients might have to attend a budgeting class, maybe join a support group, maybe skills training. Something to help keep them accountable but also to encourage them.

There are a lot of details to work out so this doesn't turn into a paradise for scammers, but when I wrote this fifteen years ago I thought it was an idea worth trying. I still think so today.

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