A fair alternative to predatory short-term loans
Many hard-working people need access to short-term credit in a pinch to cover the cost of an emergency room visit or replacing a busted stove or carburetor. Yet apart from asking friends and relatives for assistance, a wellspring that comes with its own costs and often runs dry, many families turn to alternative, “predatory” lenders to finance unexpected expenses. Although the products offered by these alternative lenders — such as payday or car-title loans — can help families weather a financial emergency, the eye-popping interest rates can be devastating.
Policymakers in Washington and around the country have sought to limit the havoc wrought by these products, largely by regulating them out of existence. But that leaves people who are caught momentarily short-handed without options, however predatory.
Yet there is another way that has been proved to work.
For more than two decades, Britain has operated a publicly financed “social fund” to provide short-term credit to low-income families. Here’s how it works: Families currently receiving public assistance — such as the British versions of unemployment insurance or welfare — can qualify for two types of loans. “Budgeting loans” provide families with a lump sum to make substantial household purchases such as a refrigerator or stove. “Crisis loans” are a last resort for families who experience an emergency that leaves them unable to meet basic expenses such as food and gas.
All these loans are interest free, issued directly by the government, and are typically repaid over one to two years through an automatic deduction from government benefits. No credit check or lengthy application is required; families are typically turned away only if they cannot demonstrate a need for the funds, or if they already have too many loans outstanding, or if the fund is out of money because the demand for loans outstrips the available capital. Even then, applicants are usually given a smaller amount as existing borrowers pay off their loans. In addition, new allocations are made to the fund each year.
The average crisis loan is about 81 pounds ($120) and the average budgeting loan is about 410 pounds ($620). Last year, the British social fund provided more than a million budgeting loans and nearly 2 million crisis loans.
This isn’t a throwaway of public dollars. Of all the money lent by the social fund over the last two decades, close to 88% has been fully repaid and just under 12% is still outstanding, while less than 0.5% has been written off as loss.
Through direct provision of short-term credit, the social fund undermines the efforts of predatory and illegal lenders while helping British families avoid the debt trap that ensnarls so many low-income Americans.
With a few tweaks to the current system, the United States could instantly adopt a similar scheme in which those who receive government assistance through welfare, disability and Social Security are eligible for small, interest-free loans that can be paid back over time through a deduction in benefits.
But why limit eligibility to those on public assistance? Although the logistics of delivery and repayment are more complex, working families who subsist just above the federal poverty line could also qualify for short-term loans that could be paid back through direct deduction from the household bank account or from their annual Earned Income Tax Credit refund. The government could charge interest — at rates far below what’s offered by private lenders — to recoup administrative costs.
Some argue that government should simply subsidize private industry to provide affordable products. But why should taxpayer dollars be used to help banks profit from something the government can do directly? This same inefficient model was used in the student loan industry, where billions of dollars were wasted subsidizing banks to deliver federal student loans until Congress ended the practice this year.
Direct loans could ultimately save taxpayer dollars. If a single mother working her way off welfare can get the short-term credit she needs to repair her car, she can continue on the road to self-sufficiency. If we give a middle-aged father credit to pay off a new medical bill, we won’t have to rescue his entire family from financial ruin after they go to a loan shark for the funds.
Better oversight of predatory and illegal loan practices is a good start, but regulation of bad lenders isn’t enough. It’s time for the federal government to compete with them.
Rourke O’Brien is a research fellow at the New America Foundation and a visiting researcher at the Centre for Analysis of Social Exclusion at the London School of Economics.