Christians and Payday Lending

I recently attended a conference in which there was a debate on payday lending, a hot button issue. One side argues that payday lending violates Biblical restrictions on rates of interest and oppresses the poor. The other side contends that payday lending provides small, short term albeit expensive loans that provide financial flexibility for people without credit cards or bank accounts, and that ultimately such flexibility helps borrowers. At the conference, payday lending was defined as follows:

“The practice of lending small amounts of money, usually $350 or less, to individuals for two week periods (i.e. until the next pay day), potentially trapping borrowers in an endless cycle of two week loans, often at an annual interest rate up to or exceeding 360%.”

This definition is clearly biased against payday lending, and with such a definition, it is no surprise that the majority of those involved in the debate were solidly against the practice. Definitions always shape the argument, and the surest way to convince yourself of the maleficence of your opponent is to define an issue in a way unacceptable to him. The surest way to achieve nothing is to fail to define terms at all. A better definition of payday lending, excluding the inflammatory commentary, would have been as follows:

“The practice of lending small amounts of money, usually $350 or less, to individuals for two week periods (i.e. until the next pay day). Rates charged often markedly exceed the annual percentage rates charged on credit cards or larger, more conventional loans.”

Opponents of payday lending often speak in personal and moral terms; that people who are involved in payday lending are evil. They frequently use the Bible to support their case. Defenders of payday lending typically speak in more impersonal and practical terms; that payday lending is good business for the borrower and for the lender alike.

What does the Bible say about loaning at interest?

We must first investigate the basic Biblical testimony on this matter. Following is a summary of the primary use of the word “Interest” (נֶשֶׁךְ neshek) which refers to making and taking loans in the Bible.

References

Exodus 22:25 – States that if anyone lends to a poor Israelite, he should not collect interest

Leviticus 25:36-37 – Specifies that a man lending to a poor Israelite should neither take interest nor any kind of increase.

Deuteronomy 23:19-20 – Suggests that a man lending to a poor Israelite should not take any kind of increase on anything lent. However, it was OK to charge interest (take an increase) to a person who was not an Israelite. Perhaps this was a concession due to the hardness of the peoples’ hearts like divorce (Matthew 19:7-8), but God allowed Israel to charge the stranger but not his fellow countryman, something explicitly forbidden elsewhere (Leviticus 19:33-34, Numbers 15:15, Deuteronomy 10:17-19, 27:19).

Nehemiah 5:7-10 – Condemnation of the nobles and rulers of Israel for exacting usury (taking interest) from fellow Israelites.

Psalm 15:5 – The man who does not loan his money at interest or for gain will not be moved.

Proverbs 28:8 – Those who charge interest and have other unjust gain will accumulate money that God will give to those who do not.

Isaiah 24:2 – In the judgment, the land of Israel will be emptied of all people, including those who deal in interest.

Jeremiah 15:10 – Jeremiah neither lent nor borrowed at interest; therefore why did others curse him?

Ezekiel 18:8,13,17, 22:12 – In these verses, the writer mentioned usury and increase separately. This could mean that he saw them as two different things, with usury being excessive interest and increase being non-excessive interest. The problem with that interpretation is that Ezekiel condemns them both.

Matthew 25:27 – The master told his servant that he should have at least invested his money so that he would have received interest.

Luke 19:23 – The master told his servant that he should have at least invested his money so that he would have received interest.

Though many modern Christians commonly understand the word usury as high interest, the Bible never provides any indication of what rates would be considered reasonable and which would be considered high. In reality, the Old Testament generally forbids any lending at any interest rate among Israelites. To say that usury only refers to excessively high interest rates, whatever those are, is not supported by the Biblical testimony. If we are going to use the Old Testament to oppose lending at interest, we must oppose it all, regardless of rates.

The New Testament takes a different track. The parable of the talents speaks without censure of lending at a profit (Matthew 25:14-30). Jesus does not condemn the money changers in the Temple for changing money, which inevitably involved a high fee. Rather, he condemned them for changing money in the Temple. It was the location, not the activity, that he condemned. The New Testament directly condemns neither lending at interest nor lending at high interest, although there are passages that rebuke the rich for oppressing the poor (James 5:1-6).

The Virtue of Interest

Economically, prohibiting the collection of interest chills the desire to lend as well as the desire to save. Except for the most virtuous, wealthy Jews would have been far more likely to lend to foreigners and see a profit than lend to their countrymen and see nothing. If there is no return on money saved, such as interest bearing savings accounts, why save at all? Expensive projects become difficult because no individual has the resources to foot the bill, and no one else will loan to them. As long as one’s basic needs are met, conspicuous consumption makes more sense. Lending is therefore a productive economic activity, as God knew long before man did.

Payday lending

Many people in the United States live paycheck to paycheck, earning only enough to meet what they consider to be their routine obligations and not having extra money to cover life’s contingencies such as car repairs, medical bills, or other unforeseen troubles. People who have no ready cash often cannot wait for a formal bank loan at 6-9% so they might use a credit card at 12-18%. Commonly they can’t get either because they aren’t financially qualified. Banks usually will not loan less than $1000 because fees are too high and risk usually too great for their business model. Some may have friends or family who can provide cash, but many do not. In these cases, the neighborhood payday loan place becomes their lender of last resort. People use payday loans for regular expenses, auto repairs, medical bills, gifts, and a host of other short term needs.

When a person in need of cash goes to a payday loan place, he or she typically has to prove only that they have a job. Payday loans are unsecured by tangible assets and therefore the lender stands to lose his entire investment if the borrower fails to return and pay. Payday lenders often do no other background check, further increasing their risk. The real interest rate on any loan is calculated as follows:

US Treasury Rate of Return + Rate of Inflation + Risk Premium.

If the US Treasury Rate of Return is 3% and inflation is 3%, the minimum rate that a lender can charge to break even is 6% plus the costs of providing the loan, which may be 2%, for a total rate that the borrower pays of 8%. However, lenders know that a certain percentage of their loans will not be repaid and so they charge a risk premium to cover these losses. If they lend to a population in which on average 5% of loans go unpaid, they can charge less interest than if they lend to a population in which on average 20% of loans go unpaid. People who use payday loan services tend to be more likely to default than people with bank loans or those who use credit cards, so payday lenders tend to charge much higher interest rates than banks.

Suppose a single mother needs $100 for unexpected car repairs and does not have a bank account, a credit card, or enough cash on hand to cover the bill. She is unable to get help from family or friends. This single mother may take out a payday loan for $100 with the understanding that in two weeks (when she gets paid) she will repay the $100 and add a $15 fee. The fee represents a 15% interest rate on the loan over two weeks, but depending upon how it is calculated, more than a 400% interest rate over one year. The poor are more likely to use payday loans, and people trying to advocate for them get sticker shock when they consider that a bank loan may cost 10% and a credit card may cost 20%. Well-meaning but often misguided, they characterize payday loans as predatory. Since people who use such services tend to be female, minority, divorced, and less educated, critics also contend that payday loans are racist, sexist, etc. (Payday Lending in America: Who Borrows, Where They Borrow, and Why Jul 18, 2012). Payday loan storefronts are illegal in 15 states and payday loans are highly regulated in many others, decreasing competition.

There is another side to the story, however. If a payday lender loans $100 but it takes one employee 20 minutes (with wages and benefits of $15 per hour) to process the transaction, the cost in employee time alone is $5.00. That leaves $10.00 to cover facilities, equipment, supplies, insurance, and other overhead associated with this loan. Further, it does not include any extra profit to make up the difference in case this borrower, or another borrower, defaults. From that perspective the $15 fee, the effective interest rate, does not seem unreasonable if the lender is to stay in business.

The problem therefore is not the interest rate but the ratio of loan size to fee charged. Small loans can take almost as much time and money to approve as medium sized ones. Using simple interest rather than compound interest to illustrate, someone who lends $100 at 400% interest might make $400 on the loan after one year, but someone who lends $10,000 at 8% interest will make $800 after one year. The first lender is condemned while the second is respected.

A study done by the New York Federal Reserve Bank in January 2007 found that while “debt traps” can be defined as tempting households into “overborrowing and delinquency”, payday lending did not fit the definition of predatory. Specifically it noted “in states with higher payday loan limits, less educated households and households with uncertain income are less likely to be denied credit, but are not more likely to miss a debt payment. Absent higher delinquency, the extra credit from payday lenders does not fit our definition of predatory (Morgan D, Defining and Detecting Predatory Lending January 2007 Number 273).” In fact, states with greater availability of payday loans had a lower cost per loan, probably because competition decreases costs.

Dr. Adair Morse did a study evaluating whether payday loans exacerbate or diminish financial distress in the context of natural disasters. He found that rates of foreclosure and larceny were less in areas better served by payday lenders than in areas that were not (Payday Lenders: Heroes or Villains? Adair Morse, University of Chicago School of Business, January 2009).”

None of these studies tell the whole story, and there are undoubtedly people caught in a debt trap of predatory lending, but on the whole the evidence suggests that payday and other short term lending does more good than harm. The book Infiltrated by Jay Richards speaks at greater length on this issue, concluding that payday lending has a valid role in our economic system.

Alternatives

If payday lending were made illegal, there would be fewer ways for people who need short term cash to get it. If the single mother mentioned above did not have access to a payday loan, she could sell possessions at a pawn shop, or take out a title loan with her car as collateral. In the first case, she would be selling items at a fraction of their value; things that she may need later and will likely be unable to replace. In the second case, the single mother may be risking her ability to get to work and generate any income at all. It is not clear that either alternative is better for the borrower than payday loans.

Conclusion

Payday lending is an expensive way to get short term cash, but it meets an important need for many people. The Old Testament restricts lending, the New Testament accepts it, and neither specifies which interest rates are acceptable and which are not. Rather both Old and New Testament tell the rich to assist the poor in taking care of themselves. The wealthy landowner Boaz was commanded to leave unharvested grain at the edges of his fields so that the poor, such as Naomi and Ruth, could harvest some for themselves (Leviticus 23:22, Deuteronomy 24:19-22, Ruth 2). Boaz was not commanded to harvest everything, make hot bread and then pass it out to whoever happened by.

In the modern context, churches can help the poor through financial management classes, voluntary charity closets, and other local initiatives. Christians can devise other sources of short term, small dollar funding that replaces payday lending with loans at lower interest rates. But to condemn the practice of payday lending and to villainize the people in the industry is to harm the poor and harm the Body of Christ.

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