New payday Loan companies

My wife and I were watching a news program the other day when a commercial for a prescription medicine piqued my interest.

The drug was designed to treat an ailment that, as it turns out, comes from taking another prescription medicine made to treat something else.

The absurdity of that inspired me to think about other instances where this might also be the case. Because of my predisposition to view such things in a financial context, I recalled a report I’d recently read on consumer-financing trends.

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It touched upon an important reason why a rapidly growing number of 20- and 30-year-olds are signing up for loans from alternative finance companies — firms that pitch payday, tax-refund, auto-title and pawn-shop loans: Because their other debt obligations are leaving them short on funds.

Researchers at George Washington University’s Global Financial Literacy Excellence Center analyzed a 5, 500 subsample of millennials who participated in the Financial Industry Regulator Authority’s (FINRA) 2012 National Financial Capability Study. They found that 42% of that subsample are currently or expect to soon become alternative financing company customers.

Why are so many 20- and 30-somethings apparently willing to risk their longer-term financial security by doing business with firms that are known for charging higher rates and fees than traditional lenders?

They haven’t much choice.

The researchers found that more than half of those surveyed were carrying credit card balances. Nearly 30% were overdrawing on their checking accounts and 20% had borrowed or taken hardship withdrawals from their retirement accounts. As such, their creditworthiness is, in a word, impaired.

What’s more, since budgeting is a zero-sum game and 54% of the surveyed millennials also said that they were concerned about their ability to repay their higher-education loans, it’s reasonable to conclude that these are the debt obligations that underlie the problem. Money woes related to student loan debts isn’t all that surprising: Roughly half of the student loans currently in repayment are either past due, in default, in forbearance or being accommodated by one of the government’s many relief programs.

So it’s quite possible that the reason why alternative finance companies are in such great shape is because the loans their customers had previously undertaken are making them sick.

Which brings me back to the absurd premise of needing a second medication to counteract the first.

If we are truly concerned about the increasing use of alternative financing products by consumers with worsening credit, it would make sense to address a fundamental reason why that deterioration is occurring in the first place: student loans.

We can start by abandoning the nickel-and-dime approach we’ve taken thus far and re-price the entire loan portfolio at rates that correspond with the government’s actual costs to fund and administer these contracts, and extend their repayment durations so that installments consume no more than 10% of a typical borrower’s monthly earnings.

Student loans would then become more affordable, and, as a direct result, the need for financing products that have the potential to compromise consumers’ longer-term financial health can mostly become a thing of the past.

This story is an Op/Ed contribution to Credit.com and does not necessarily represent the views of the company or its partners.

Interesting facts

• As banks and building societies close their doors to all but the least 'risky' borrowers, Dispatches reporter Jane Moore investigates a highly lucrative financial industry that has stepped in to provide loans to the millions of people denied credit elsewhere.
  She discovers that many of the loans offered by some of these doorstep operators...