Washington, D.C., February 6, 2012—So-called “payday loans” and other forms of non-bank , short-term credit are roundly vilified by many politicians and activists, including the Obama White House. But a new report from the Competitive Enterprise Institute finds many “dubious arguments” are made about the true costs of such credit.
In the CEI OnPoint, “The 400 Percent Loan, the $36,000 Hotel Room, and the Unicorn,” John Berlau explains why political attacks on such loans are both wrong and harmful in limiting the options of the very people they’re aimed at protecting. Berlau argues that “annual percentage rate” is the wrong lens to look through to pass judgment on short-term credit.
The Obama administration and other politicians who subscribe to a “destructive myth of 400 percent interest” use a flawed method of calculating interest that makes an apples-and-oranges application of annual percentage rate (APR) to loans of a much shorter duration than one year.
“Were a borrower to take out a new loan every two weeks for a year, the total would indeed equal 420 percent [but] the only problem with that scenario is that it does not match reality,” Berlau explains. “State government data on payday loans show that hundreds of thousands of borrowers take out just one loan per year and pay back the loan within the two-week duration. Even staunch critics of payday loans have yet to name a single individual who has paid close to 400 percent over a year from a law-abiding lender.”
In the report, Berlau also tells why proposed APR limits of 36 percent or lower are destructive below-cost price controls, why the so-called “debt cycle trap” is a myth, and why payday loans are often the most affordable alternative among limited options for short-term credit.
At the same time, Berlau also calls for lifting government barriers to potential payday alternatives, such as installment loans. “America needs a variety of options in short-term credit,” Berlau concludes. “Liberating the market for such credit offers the best prospect of improving the financial well-being of households at risk.”
> View the CEI OnPoint, The 400 Percent Loan, the $36,000 Hotel Room, and the Unicorn
> Read more by John Berlau, Director of CEI’s Center for Investors and Entrepreneurs