# Microloans vs. payday loans

Phil Cubeta’s recent post about payday loans got me thinking about our choice to grant a microfinance organization in our Global Poverty cause.

We decided to grant Opportunity International for two reasons:

• The belief that there is likely a significant shortage of access to credit in the developing world.
• The very fact that someone repays a loan with interest likely demonstrates that the loan is used for something that is likely life-improving.

But, doesn’t the same analysis apply to payday loans? I’d bet that there’s a similar lack of credit for very small loans for borrowers with questionable credit-worthiness. And the very fact that lenders run this business likely indicates that borrowers are consistently paying back their loans, even at exorbitant interest rates (400-1000% annualized, according to the Center for Public Policy Research). The same logic that says microfinance is helping people would seem to imply that payday loans are as well.

On the other hand, it’s also possible that many borrowers are only able to repay their loans by taking out another loan – that what we’re witnessing is not a group of people getting back on their feet, but a group of people getting caught in a cycle of debt. Note that this could be numerically consistent with very high (~95%) repayment rates, the statistics commonly cited by microfinance organizations to illustrate their effectiveness in helping people – someone who borrows to pay off another loan 19 times, before finally defaulting, has a 95% repayment rate.

We’re left with two plausible yet conflicting hypotheses about the way in which the practice of making small loans at relatively high interest rates affects those in need. In one case, those in need access much needed credit (albeit at high interests rate) which allows them to weather a difficult financial period and potentially pull themselves out of poverty. In the other, those in need borrow and ultimately find themselves in a debt trap, borrowing more to repay previous loans.

We’ve generally been very frustrated with how little information we’ve been able to get on microfinance operations – who is borrowing, what they’re using the loans for, what their standard of living is, and what happens to that standard of living over time. Without this kind of information, we’re still only guessing at whether microfinance organizations and payday loan operations are helping people pull themselves out of poverty, or simply helping them get caught in cycles of debt.

### Comments

• Nonprofiteer on March 12, 2008 at 1:40 pm said:

Please note the Nonprofiteer’s take on this subject at http://nonprofiteer.typepad.com/the_nonprofiteer/2008/03/often-the-satir.html

• John J. on March 12, 2008 at 2:43 pm said:

Elie, You missed the irony in Mr. Cubta’s post. And besides, payday loans are a different species of loan from those offered in microfinancing. Payday loans are basically consumer loans that take advantage of poor people by charging usurious interest. Microfinancing provides business loans–captial–, so that recipients can become self-sustaining. I’m not sure what you are getting at with this comparison, considering you are comparing apples and oranges.

• Grant on March 13, 2008 at 2:29 pm said:

I don’t appreciate being put in the same category as the imbeciles who are getting stuck in a “cycle of debt”. I am a payday loan customer and I use them responsibly, as do most of the payday loan customers. The fact is that more than 90% pay their loans back on time and get an average of 5 or less loans per year. It is only a few spoiled apples who are ruining it for the rest of us. We need to stop blaming the payday lenders for everyone else’s irresponsibility! If I borrow 100 bucks from a friend, and am not able to pay it back, I don’t blame my friend for lending me the money! That is just stupid. So why are we blaming our payday lender friends for providing a great service? In a recent article by ex senator and presidential candidate George McGovern, he says, “[p]ayday lending bans simply push low-income borrowers into less pleasant options, including increased rates of bankruptcy,” Mr. McGovern rightly poses the question: “Why do we think we are helping adult consumers by taking away their options?”
Later in the article, he says, “[t]he nature of freedom of choice is that some people will misuse their responsibility and hurt themselves in the process. We should do our best to educate them, but without diminishing choice for everyone else.”
This is how we need to look at this topic. Leave the payday loan stores alone and look for other options. Instead of taking away payday lenders, beat them at their own game by giving consumers even more alternatives!

• i agree w/John J above that the intent of use behind microlending vs payday loans bears consideration and makes comparison difficult, perhaps unwarranted. its still an interesting question as to the help payday loans provide and their structural similarity (e.g. small and personal) to microlending.

two questions on my mind:

1. why hasn’t competition in the open market lowered the huge rates payday loan providers can charge?

2. if payday loans are really ultimately just a revolving door into a downwards credit spiral, then ultimately, how is the industry making money? arbitraging the US governments bankpruptcy laws? seems doubtful. it’s hard for this guy to believe that the entire portfolio of these loans aren’t ultimately secured by exactly what they claim to be: future income streams which are spottily managed because, ultimately, being poor, makes each unexpected wave that rolls in towards shore, harder to deal with than you or i really understand.

• Dario Amodei on March 14, 2008 at 4:58 pm said:

Since many microfinance organizations provide repeated loans to the same people, it might be possible to address this question by looking at patterns of lending, re-lending, and default. If the average borrower is taking out 19 loans and then defaulting on the 20th, then I’d be worried they were trapped in a cycle of debt. If, on the other hand, most of the defaults came from a few first-time borrowers, while the average user is borrowing many times without ever defaulting, that would suggest that microfinance is working for most people.

All you’d need to do this is a list of borrower names, dates, amounts, and repayment status. It wouldn’t be a bulletproof analysis, but it might be a start.

• grantalupus on March 18, 2008 at 12:31 pm said:

Why does it have to be all or nothing? “…but a group of people getting caught in a cycle of debt.”
I am a payday loan customer and several people I know are as well. None of the people I know, including myself, have ever gotten a second loan to pay the first loan. So why are you generalizing? This is a dumb topic anyway, the answer to this payday loan “problem” is to leave it alone and if people are misusing it and hurting themselves, then they are only hurting themselves. If I choose not to wear a helmet when I ride my motorcycle, I am only hurting myself. We need to stop blaming lenders for the mistakes of the consumer. If you are going to borrow money, you need to be held accountable, if you cannot afford to borrow, then don’t! Simple as that.

• It is a common assumption and misconception that the majority of those who take out payday loans are poor or in poverty. It would be a ridiculous business practice for any for-profit entity to offer a product to a customer who doesn?t have the ability to pay back. Any reputable lender, long or short term, has minimum qualifications and underwriting procedures. In addition, payday loans are often referred to as ?usurious? because the Annual Percentage Rates, not the Interest Rates are considered high compared to traditional loans. This is only a focus because payday lenders HAVE to attach an APR to a loan that actually has a max term of 2-4 weeks.

• Doug S. on March 20, 2008 at 10:15 pm said:

Well… one can still make money on a debtor who goes bankrupt, if they pay back *enough* before they go broke. If you end up having to pay a total of $3,000 on a loan of$1,000 (thanks to ridiculous interest rates, borrowing more to make payments, etc.), but go broke after paying back $2,000, the lender has made a profit of$1,000 but you’re still broke.

• Morris Jones on April 11, 2008 at 12:58 am said:

Same day loans are the parts of payday loans. For urgent need of cash same day loans are very helpful. Normally for a salaried person it is not possible to have immediate access to the money. With the help of same day loans borrowers can have instant access to the much required money without any paper works. visit http://www.paydayloans-fastpaydayloans.blogspot.com/

• Dave Loan on June 28, 2008 at 2:53 am said:

What is your opinion of payday loan establishments?
In some areas of the country they are trying to ban payday loan stores, citing predatory practices and unfair interest rates. These places have clearly listed their rates, as high as they are, on paper and listed in signed contracts. Opponents of the proposed law banning payday loans say that the extra fees are better than not getting money for a needed car repair, a bill that must be paid (electric, gas) or bouncing a check because the money was not in the account. What’s your take on these places. Explain your position.

• Tommy Payday Loan on September 18, 2008 at 10:27 pm said:

I feel like payday loans are still a good option. Think about it: just about anyone can qualify, and let’s face it — in medical or bill emergencies, you don’t have time to think about the future ramifications, you just need the money now — not later. It’s easy to look condemn payday loans as a downward spiral, but emergencies are just that: emergencies.

• Dean white on October 28, 2008 at 11:52 pm said:

its sad but true, most single family or low income workers only have the options of payday loans, It causes problems because of the high intrest rates to pay back the loans.
MyquickLoan

• MoneyAmulet on November 3, 2008 at 4:00 pm said:

Payday loans is good thing.

• Payday Loans USA on March 12, 2009 at 6:57 pm said:

Consumers prefer payday loans to face small, unanticipated expenses while avoiding costly bounced-check fees and overdue payment penalties.

• Carl Shulman on March 12, 2009 at 8:55 pm said:

Please prune the spam.

• Holden on March 16, 2009 at 12:05 pm said:

We try to err very far on the side of not deleting comments once posted. However, going forward, we’ve instituted a policy where comments on posts more than 120 days old will be sent straight to moderation, and approved only if relevant. Commenters on relevant posts will be given this warning.

• rose on April 1, 2009 at 9:17 am said:

For most people borrowing money is not the way they would choose to go IF they had a choice; for people with bad credit it’s a double nightmare.It can require a great deal of paperwork and turn into an embarrassing situation. Thus, consumers prefer payday loans to face small, unanticipated expenses while avoiding costly bounced-check fees and overdue payment penalties.

• raya on April 6, 2009 at 2:50 pm said:

For most people borrowing money is not the way they would choose to go IF they had a choice; for people with bad credit it’s a double nightmare.It can require a great deal of paperwork and turn into an embarrassing situation. Thus, consumers prefer payday loans to face small, unanticipated expenses while avoiding costly bounced-check fees and overdue payment penalties.

• Niawu Lirvi on May 19, 2011 at 4:27 am said:

Property values fall and crime rates rise when payday advance lenders move to the neighborhood, according to a new study. The academic literature doesn’t reach consensus, and this isn’t the first time that the two things have been linked. The total impact of payday lenders is not entirely known. It may be impossible to know if payday loans are truly a force for good, evil or occupies a gray area. Here is the proof: Study blames crime rates on payday loan lenders, personalmoneystore.com/moneyblog

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