Until 2008, a cash-strapped customer in Ohio seeking a quick two-week loan from a payday lender could find themselves paying high fees. These unsecured short-term loans – often secured by a post-dated check and rarely exceeding $500 at a time – carried annual percentage rates (APRs) of up to nearly 400%, more than ten times the normal limit allowed by usury laws.
Then, 11 years ago, the state stepped in to make these loans prohibitively expensive to offer. Ohio’s short-term loan law limits the APR to 28%, reducing margins for predatory lenders and effectively banning payday loans in the state. But while the law was intended to protect the poor, it instead seems to have sent them rushing to other, equally insecure alternatives.
A new economics article by Stefanie R. Ramirez of the University of Idaho, published in the journal Empirical Economics, looks at the effect of legislation. Although he was successful in ending the loans, Ramirez argues, it had the unintended effect of shifting the problem to other industries favored by people with few alternatives and bad credit. Potential borrowers now rely on pawnbrokers, overdraft fees and direct deposit advances to quickly find themselves in the dark when times get tough.
Ramirez used Ohio state licensing records to measure changes in the number of pawnshops, precious metals dealers, small loan lenders and second mortgage lenders operating in the state. . Once the laws were introduced, she writes, the number of pawnbrokers in Ohio grew by 97%, while small moneylenders and mortgage lenders grew by 153% and 43% respectively.
Pawnshops may seem Dickensian — hanging on to a beloved family heirloom to avoid being sent home from work — but they’re an integral part of the American financial landscape. there is around 12,000 of them across the country, each operating on a similar model: customers in need of hard cash bring something worth selling, which they will hand over for between 40% and 60% of the value of the item. Over the next few weeks or months, they slowly repay their loan, plus storage fees and interest of up to 400% per year. (In Ohio, interest is capped at 6% per month or 72% per year.)
If the borrower cannot repay his loan, the object is kept by the pawnbroker and sold to a paying customer. As payday loans come under threat across the country, Robbie Whitten, the managing director of Money Mizer Pawn and Jewelry in Georgia, told the New York Times“we kind of evolved into, I like to call it the poor man’s bank.”
It’s not a model most would choose – who would risk losing something they love? – although it has some attributes: pawnbrokers are easy to find, quick to find money, and don’t research or report credit scores. You don’t even need a bank account.
People with bad credit are often drawn to payday loans after being excluded from safer alternatives. A study cited by Ramirez found that 73% of payday loan users had had credit extension applications rejected or limited in the previous five years. And their timeliness matters, too: loans are often used for essential payments for utility or phone bills.
As a way to eliminate payday loans, Ohio’s STLL law worked. But from a consumer protection point of view, it was a little less successful. “Policymakers may have simply moved operating companies from one sector to another, having no real effect on market conduct,” Ramirez writes.
Without eliminating the reasons why people might seek out payday loans and giving them access to safer borrowing options that they are currently excluded from, it is difficult to see a good alternative solution for potential borrowers. For the desperate, the risks and debts associated with pawning a cherished engagement ring may be even less appealing than watching the barrel of growing payday loan debt.