Payday loans can help people of moderate income as well as harm them. The very high interest rates of payday loans can harm people who try to use them inappropriately. Using payday loans to avoid higher costs from other very short term debts can help people who can’t get any other kind of credit. Banning or otherwise greatly restricting payday loans online can often hurt people of moderate incomes more than help them. Education about payday loans can greatly mitigate the potential downside for people most likely to use payday loans.

Payday loans normally come with a very high interest rate. A typical payday loan of $100 requires a repayment of $115 in one week. If it is not paid back, the borrower owes another $15 to maintain the outstanding loan. In less than two months, this means the amount to be repaid is $220 or more than twice the initial loan amount. This interest rate is normally well over 200-300% if calculated annually. The reason for this extremely high rate is the default rate is also very high, in the range of 10-20%. This is compared to a typical high risk credit card with an interest rate of 20-25% annually. If the payday loan is not paid off immediately but rather another loan is taken out to pay the first one the amount owed can rise at a very rapid rate. This is the trap of payday loans.

However, using a payday loan to avoid a fee for not paying another debt can be an effective strategy for low and moderate income consumers. In the case of paying $15 interest to avoid a $75 overdraft fee, for example, a payday loan can be quite effective in saving what little money some people have. Particularly people who do not have access to other forms of credit. Another benefit of payday loans is many payday loan companies report their customer’s loan payoff record to the major credit reporting agencies, allowing people to build credit who might otherwise not be able to.

Banning payday loans removes this potential benefit from all consumers. Without the extremely high interest rates, payday loan providers would not be about to maintain a profitable business. The default rate on payday loans is simply too high to effectively allow for such a strategy. Educated use of payday loans by the consumer to avoid higher costs of not having access to such loans at all is a positive economic outcome.

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