Case Analysis: Personal Finance
Short-term lending is a process designed to offer small amounts of financial help to individuals for a short period of time. Payday loans originated roughly twenty years ago when check cashing stores began to give advances on an individual’s next paycheck. As regulation increased and the government limited the fee’s banks are able to receive on credit and debit cards, a new form of lending arose from several well-known banks giving deposit advance loans. These are loans set for a short period of time with high interest rates. In 2012 a study by the Pew Charitable Trust estimated 12 million Americans use payday advance loans every year. However, with these loans comes much controversy as many of these loans take American citizens further and further into debt.
The topic of short term lending has two very conflicting arguments. On one hand, short-term loans are a useful tool that allows an individual access to credit he or she would not have otherwise been able to receive in the event of an economic crisis. They are designed to give aid to immediate expenses such as people at risk of losing car, losing utilities, or outstanding rent payments. For these individuals a short-term loan is a necessity of life. On the other hand these loans come with a steep price and can result in an avalanche of debt that will accumulate and grow over time. These loans are very easy to obtain and yet very hard to eliminate. Many individuals who receive this financial aid are not able to pay it back in the given time. Studies by the Pew Charitable Trust show that an average payday loan requires a payment of $400 within two weeks. However, the average individual using these loans can only afford to repay $50 within the given time frame. In result the debt continues to accumulate with growing interest. These contradicting views bring rise to several questions such as; are they helpful or hurtful? Should the government put a ban on short-term loans? Should the government place stricter regulations on such loans?
I do not believe a complete ban of short-term loans is the right solution. Tom Lehman an economics professor at Indiana Wesleyan University stated “Banning payday lending actually does more harm than good by restricting credit options for households with no other recourse for loans.” There are several positive benefits a short term loan can offer to those in mid crisis or emergency with no extra money to support themselves. No every short term loan results in a never ending cycle of debt. However, that being said, the government needs to develop a system where short term loans do not lead to a “debt trap” as program director at Lutheran Social Service Financial Counseling calls them. A leading cause to debt created from these loans is due to the fact that the lender is able to renew the loan if not repaid in time and continue charging interest. The lender can also connect themselves to the borrower’s bank account and request payments as necessary. If an individual does not have enough money in the account, the bank account will be over drafted, resulting in more fees. A system should be put in place that allows individuals with high credit scores, or limited opportunities to quick cash, to take out a short-term loan. To avoid continuous debt and interest charges, short-term loans should only be offered with a strict agreement of repayment options and advance agreements to end the loan when necessary. This will avoid the habit of renewing loans and spending money the individual cannot afford to pay back. There should also be stricter regulations on the interest rates able to place on a loan. According to research by Pew Charitable Trust the average borrower receives eight loans a year of $375 or more. In result the borrower will pay $520 in interest on average. An individual who has a previous record of not paying back their short-term loan in a timely manner should not be allowed to receive or renew a loan.