Oct 8, 2016 4 min read

The Consumer Financial Protection Bureau has released proposed regulations for payday loans, which are small, short-term loans at exorbitant rates of interest, the niche historically dominated by loan sharks.

The idea is that the person borrowing the money is short on cash, and will be able to repay it at the next paycheck. In reality, what often happens is the person cannot repay the entire loan, so they pay some of it, and then roll over the remainder, paying additional fees. Four out of five borrowers do this many times, most more than 10, with the result being that, while they could have repaid more than the original amount of the loan, they still owe money because most of what they’ve paid has been interest and fees.

The industry argues that high fees and interest rates are required to provide enough revenue to justify the effort required to make the loans. On the other hand, because of the interest and fees, the lenders can often make money even on the borrowers who eventually default.

The CFPB proposes requiring that the lenders document that the borrowers have the ability to repay the loans before making them, so people who are unlikely to repay the loans will not be able to get them, thus avoiding bankruptcy or ruining their credit. This is an attempt to learn from the mortgage crisis of 2007 and 2008, where many borrowers got loans they could never hope to repay.

But just because a borrower does not fit the standard definition of a good risk does not mean they do not need the money or will never repay the loan. And a small, short-term loan is very different than a 30-year mortgage. The new regulations do exempt loans of less than $500 from the requirement that lenders be able to document the borrowers’ ability to pay, so it does allow borrowers the right to take a small risk. But that right is costly. While the cost of a payday loan is high, it can still be less than a late fee or a bounced check fee that its use avoids.

The problem is that these new regulations treat the symptoms – in this case, the likelihood of default – rather than the disease, which is the need for cash. The industry can be predatory, but the reason it is able to thrive is because no one else is willing to make small, short-term loans with no collateral. But people without adequate savings need a short-term loan when they are presented with a crisis – someone gets sick and cannot work, or a car breaks down. Wealthy people will have savings or the ability to borrow from conventional banks at reasonable rates. But many people do not have access to those resources. Some can borrow from family members or friends, but for the poor, their friends and relatives are often also short of cash.

The need for short-term cash is not restricted to the poor. According to a 2015 report from the Federal Reserve, 47 percent of all Americans do not have the resources to cover an unexpected $400 bill. Instead of payday loans, many in the middle class use credit cards. The interest rates are not quite as high as payday lending, but they are steep. In 2013, more than 38 percent of families carried credit card debt.

A possible solution is for the federal government to fill this need, by allowing each taxpayer to have access to a $500 line of credit. The money could be distributed electronically through bank accounts, or for those without accounts, by the U.S. Post Office (many countries have postal banks, and post offices already exist in almost every community).

The money could be repaid at reasonable rates, and if the payments are on time, then there would be small processing fees, but no interest. The fees would help defray the processing costs, and might sustain post offices, as their business for regular mail continues to decline. If payments are not made, then the borrower would not be able to borrow additional money until the balance is paid off, and any tax refunds would go toward paying off the balance. It is difficult for banks to provide this service, but by eliminating the costs associated with determining credit-worthiness, and by using existing infrastructure, the government can fill this need.

Many people already use their tax refunds to repay debt, but being able to access it when it’s needed eliminates fees and penalties. This would also enable “unbanked” people to build a credit history that could demonstrate their ability to repay a nonpredatory loan and enable more borrowers to get loans from conventional sources.

Kent James is an East Washington resident.