A large number of innovations have taken place in the finance industry in the last few decades. Various credit programs tailored to the needs of the consumers were introduced which include credit cards, payday cash advances, home equity credit and the like. However, all these credit facilities have certain problems associated with them as well. This is because the responsibility of managing one’s money has led to many people struggling in order to repay their debt. But at the same time, people who keep away from these credit facilities end up getting marginalized as all economies are structured around these financial assets only.
What is Payday Lending?
Payday lending is a new kind of consumer finance option which works as a credit instrument for the borrower till the time he receives his next paycheck. In a typical payday loan, the borrower gives a post dated check to the lending company and receives cash in return for it. On the next payday, the lending company gets back the loan amount by presenting the post dated check in the bank.
According to the Center for Responsible Lending, payday lending is used to lure people into the debt trap as borrowers take short term loans at extremely high rate of interest. The interest rate along with the transaction costs are so high that borrowers often end up taking more loans to pay their existing loans. This leads them to a vicious cycle of lending revolving around high cost, short term credit.
Relevance of Payday Lending
Though on the outside, it appears that the lenders are exploiting the borrowers by means of payday loans. However, the large size of the APR is justified as the credit companies have to complete all formalities such as processing of paperwork, running credit check and the like irrespective of whether the loan amount is 100 dollars or 100 thousand dollars. Since the payday loans are usually for small amount and small term, the transaction fees appears unreasonable.
If we see from the borrower’s perspective, people with limited or poor credit history are the one’s who turn to payday loans. In the difficult times, it is often very difficult to get credit from other sources. Payday loans are a good source of liquidity when one requires it the most. These lenders provide an opportunity to the borrower to establish a good credit history.
Another important thing to be considered is the risky option of government supervision through the loan amount and the frequency restrictions. These regulations result in the formation of market distortions that lead to many problems. For instance, the limits on the loan frequency and amount ignore the emergency needs or individual situations of the borrowers. Loans are most often taken for urgent and critical needs, therefore the government regulations often do not allow the borrower to meet their important needs.
Payday loans were created with a view to serve the underrepresented segment of the market. The government regulations imposed on the payday loans do not allow the lending companies to come up with innovations and better solutions for meeting the needs of the borrowers in a better and more efficient manner.