Restrictions on payday loans will hurt low-income borrowers in Golden Valley
Recently, the Golden Valley City Council passed a law to 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 due to their exorbitant interest rates. In Minnesota, for example, interest rates on payday loans can reach as much as 200 percent. Furthermore, according to the Pew Research Center, payday loan users tend to be low-income individuals, earning less than $40,000 per year.
Unfortunately, however, while restricting payday loans appears to be a no-brainer, the evidence suggests it could backfire.
Evidence
According to research 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.
Restrictions on payday loans, therefore, hurt low-income individuals by denying them cash when they need it most.
In fact, an NBER working paper found that long-term borrowers can accurately predict when they need to borrow. This 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 reduce welfare.
These findings are supported by a previous 2011 research paper, which 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.