The Alberta government has announced that it will be taking aim at the pay day loans business with legislation to be called “An Act to End Predatory Lending”. A recent article in the Calgary Herald provides some background.
Politics missing the real issue
The purpose of the act will be to curtail exploitive interest rates found to be common in the pay day loans industry. It is certainly easy to see why there isn’t much political risk in this kind of legislation. With effective annual interest rates on some loans nearing 600% (with the inclusion of admin fees etc. on very short term loans) it is hard not to conclude that the lowliest of borrowers are being taken to the proverbial cleaners. Of course the pay day loans industry isn’t happy, but they don’t count for much come voting time.
While this may make for good political strategy, it is important to step back for a moment and take a look at the big picture.
The fact of the matter is that the pay day loans business is just like any other. Let’s assume that it is truly competitive and the business model is the same for all players. If so, then we must also assume that profits can not be ramped up substantially by cutting rates and fees in order to increase volume and market share. If this was possible then it would have already happened. It is likely that the market has already found a level of sustainable pricing within a competitive environment.
This may sound extreme when thinking about 600% effective annual interest rates, however we have to remember that a $500 loan for two weeks takes a lot more administration per dollar of loan versus a $250,000 mortgage renewed every five years for 25 years. The delinquency rates are also obviously extremely high on pay day loans and recoveries on default can be assumed to be zero. While I am not an advocate for the pay day loans business, a lot of people are being forced to use them to get from pay cheque to pay cheque and that is precisely the issue we should be focused on.
Borrowing is the only Option
Speaking of predatory lending, an argument could be made that the big banks are just as predatory but perhaps in a much more subtle way. Ask yourself this – How many Canadians can afford to buy a home without a mortgage? That’s right, save up the $150,000 for a starter home somewhere on Vancouver Island. Let’s forget Vancouver! The vast majority of Canadians can’t even afford to buy a car without a car loan.
Oh, but look at how low mortgage rates are? Yes, but that is precisely the reason it is impossible to save for a small starter home. Low and still dropping rates have in effect pushed up house prices steadily and consistently for the past 20 to 30 years. This requires more and more capital to purchase a home. This in turn makes the advent of ever larger mortgages an absolute requirement for a home purchase.
On the other side of the coin we have interest rates paid on savings. Someone please explain to me how you can save any meaningful amount when interest rates on savings are effectively zero and heading negative. Why would you even start putting money away?
Increasing Debt Dependency
The fact of the matter is that we have become debt junkies. We seem to have no option but to play ball with the financial institutions. Our entire economy depends on borrowing. Any slow down in borrowing is typically viewed as a threat to our entire “financial system” and “economy” which are now pretty much synonymous with one another. I’m the first one to admit that even my business depends on it!
The bottom line is let’s not to get too carried away throwing mud at the pay day loans industry. We really need to ask why it exists in the first place.
Call us today if your debt situation is getting out of hand. You are not alone!