Restrictions on payday loans will hurt low-income borrowers in Golden Valley

Just recently, the Golden Valley City Council took the effort to enact measures that if approved will restrict payday lending.

The Golden Valley City Council took action Aug. 17 to safeguard its community against “predatory lenders” via zoning regulations. An amendment to the city code, which will undergo a second hearing and final round of approvals at an upcoming meeting, will restrict where payday lenders, currency exchanges, pawnshops and precious metal dealers can set up shop.

The new code is the result of a year-long moratorium that prevented new business from the three specialty areas, in an effort to research whether the business types had an effect on crime, safety, and customer health. It restricts the businesses to commercial zones only, and prohibits them from being established within 750 feet of each other. Other parts of the code require visibility of entrances from right-of-way and into store windows.

Payday loans have a bad reputation — and for a good reason. Interest on payday loans tend to be exorbitantly high. Not only that, but it is usually low-income, credit-crunched individuals that frequent payday loan establishments.

In Minnesota, for example, interest rates can go as high as 200 percent, and according to the Pew Charitable Trusts, payday loan users tend to be low-income individuals usually earning less than $40,000 a year. It is not surprising that Golden Valley is following in the footsteps of other cities like Moorhead that have taken action to limit such practices.

Do these restrictions help?

If you view payday loans as exploitive, of course, efforts to restrict them probably sound good. It does make sense to protect the vulnerable poor from being exploited into paying high fees by greedy loaners. But one thing we have to wonder is if whether these restrictions really help low-income individuals.

In order to do that, we need to understand why people take payday loans in the first place regardless of the high-interest rates.

Payday loans generally exist because they are necessary. To some people, payday loans are the only fast and convenient source of cash. As explained by the St. Louis Fed,

Payday loans fulfill a need for many people, especially consumers who don’t have access to traditional loans or who have no or low credit scores.18 In 2017, estimates show that among U.S. households, 6.5 percent (8.4 million) were unbanked; and 18.7 percent (24.2 million) were underbanked—that is, they had a bank account but used alternative financial services, such as payday loans.19 With bad credit (no or low credit scores), these consumers are often unable to get traditional loans, so they turn to alternative lenders. 

So, contrary to helping individuals, restrictions on payday loans actually end up hurting low-income individuals by denying them cash when they need it the most.

In fact, an NBER working paper found that long-term borrowers can accurately predict when they would need to borrow, which helps them pay off loans early thereby reducing the total cost of borrowing. For those borrowers, policies that limit choice and access to such loans such as caps on loan sizes and loan bans actually reduce consumer welfare –– that is the benefit/satisfaction that borrowers get from accessing such loans.

Additionally, a 2011 research paper also found that “restrictions could deny some consumers access to credit, limit their ability to maintain formal credit standing, or force them to seek more costly credit alternatives.”

Policies should be judged by their results, not intentions

It is not wrong to have good intentions and want to help. But a recurring theme in public policy has been to focus on the good intentions on which some policies are enacted rather than the actual effects of the said policy.

But much like other policies intended to help the poor that merely end up causing harm, restrictions on payday loans are no different. Payday loans are usually used by individuals that do not have access to other less costly ways of borrowing or would really use fast cash.

This is why blindly enacting policy that takes that option from those people in an aim to protect them against high-interest rates leaves them in an even worse situation.