Since its inception in the 1990s, the payday lending industry has grown at an astonishing pace. Currently, there are about 22,000 payday lending locations—more than two for every Starbucks—that originate an estimated $27 billion in annual loan volume.

Christians and others worriedabout the poor tend to be very fortable with this industry. While there may be forms of payday lending that are ethical, the concern is that most such lending is predatory, and that the industry takes advantage of the poor and others in financial distress.

So what makes a payday loan a predatory loan? The obvious answer would seem to be “high interest rates.” But interest rates are often tied to credit risk, and so charging high interest rates is not always wrong. Another answer may be that the loans appear to be targeted toward minorities. But research shows that the industry appeals to those with financial problems regardless of race or ethnicity.

What then tips a loan into the predatory column? At a blog hosted by the New York Federal Reserve, Robert DeYoung, Ronald J. Mann, Donald P. Morgan, and Michael R. Strain attempt to answer that question:

Except for the ten to twelve million people who use them every year, just about everybody hates payday loans. Their detractors include many law professors, consumer advocates, members of the clergy, journalists, policymakers, and even the President! But is all the enmity justified? We show that many elements of the payday lending critique—their “unconscionable” and “spiraling” fees and their “targeting” of minorities—don’t hold up under scrutiny and the weight of evidence. After dispensing with those wrong reasons to object to payday lenders, we focus on a possible right reason: the tendency for some borrowers to roll over loans repeatedly. The key question here is whether the borrowers prone to rollovers are systematically overoptimistic about how quickly they will repay their loan. After reviewing the limited and mixed evidence on that point, we conclude that more research on the causes and consequences of rollovers e before any wholesale reforms of payday credit.

The authors briefly consider a range of factors and are convincing on all but one: the problem of “spiraling” fees, which I believe arethe core problem with rollovers.

But first, here’s a brief reminder of how payday lending—and rollovers—works. If you have a job (and pay stub to prove it), a payday pany will allow you to write and cash a post-dated check. For this service pany will charge a high (sometimes absurdly high) interest rate. The authors of the article give this example:

Suppose Jane borrows $300 for two weeks from a payday lender for a fee of $45. If she decides to roll over the e payday, she is supposed to pay the $45 fee, and then will owe $345 (the principal plus the fee on the second loan) at the end of the month. If she pays the loan then, she will have paid $90 in fees for a sequence of two $300 payday loans.

They make the peculiar claim that this is not “spiraling”:

Perhaps it is just semantics, but “spiraling” suggests exponential growth, whereas fees for the typical $300 loan add up linearly over time: total fees = $45 + number of rollovers x $45.

Indeed, it is just semantics since most loan consumers would not see a much difference between “exponential growth” and “linear growth,” especially when in a matter of weeks the fees can exceed the amount of the loan.

They do admit, though, that the problem is “all about the rollovers”:

So if payday loan fees petitive and don’t spiral, and if lenders don’t target minorities, and if the academic research on the pros and cons of payday credit is so mixed, what’s left in the critique against payday lenders?Rollovers. Payday lenders oftenpitchtheir two-week loans as the solution to short-term financial problems, and, true to form, about half of initial loans (those not taken out within fourteen days of a prior loan) are repaid within a month. Potentially more troubling is the twenty percent of new payday loans that are rolled over six times (three months) so the borrower winds up paying more in fees than the original principal.

Critics see thesechronicrollovers as proving the need for reform, and in the end it may. A crucial first question, however, is whether the 20 percent of borrowers who roll over repeatedly are being fooled, either by lenders or by themselves, about how quickly they will repay their loan.Behavioral economistshave amassed considerable evidence that, contrary to tenets of classical economists, not all people always act in their own best interest; they can make systematic mistakes (“cognitive errors”) that lower their own welfare. If chronic rollovers reflect behavioral problems, capping rollovers would benefit borrowers prone to such problems.

The authors correctly identify the problem but they assume the “cognitive error” must be in being “fooled” (either by the lender or by oneself) about how quickly the loan can be repaid. I think there is another explanation.

About twenty years ago I made some terrible choices and found myself in a serious financial bind. The amount I needed wasn’t much—about $200—but without it I wouldn’t have been able to pay my rent. I took out a payday loan that cost me $30 every two weeks. It took about eight weeks to get clear of the loan, resulting in a cost of $120 to borrow $200 for two months.

Was I fooling myself thinking the loan could be paid in two week? Not at all. In fact, I knew quite well that there was likely no way possible for me to pay it off in that timeframe. I knew precisely how much money I was going to be able to earn and how much my expenses would be during that two-week period. I had, roughly speaking, about $40 a week that I could apply toward the loan.

But $40 was not sufficient to cover the balloon payment of $200 that was due at the end of two weeks. So I had to roll over the loan, applying $15 a week to the new fees and saving $25 a week to be paid toward the principal. That is why it took me eight weeks to pay off the original loan: $25 a week for principal + $15 a week for fees = $40 x 8 weeks = $320 ($200 for principal + $120 for fees.

If you’re middle class and think of it in terms of interest rate, that repayment cost sounds appalling usurious. And it is. But as the poor will tell you, man does not live on APR alone. Having to pay an extra $120 was cheaper than having to find a new place to live. Yes, it was a bad deal. But it was better than all my other choices. I didn’t agree to the loan because I was bad at a math; I did it because I was desperate. Andthe payday pany was more than willing to take advantage of my desperation.

How then do we solve the problem of rollover fee that take advantage of the poor when they are in dire straits? I believe a helpful first step would be toget more churches and other faith-based organizations involved in providing alternatives mercial lending agencies. After all, caring for the poor is not just about food banks and handouts. Sometimes the best way to help those in need is to provide a financial bridge during desperate times.