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The History and Evolution of Payday Loans
You might think of payday loans as a modern way of borrowing money. Powered by technology, today’s short term credit facilities enable lenders and borrowers to link up quickly. The internet may have revolutionised payday loan markets, but the concept of lending small amounts to be repaid when an individual can afford to do so is hardly a new one.
The history of payday loans can really be traced back as far as the invention of money. In fact, the origin of little loans was probably before that – to whenever people began lending things for a short period to then be recompensed to the lender with some form of material gain (i.e. interest) in return.
While the origins of lending between people are ancient, payday loans in the form we now know them are a little more modern. Essentially, a payday loan involves lending a relatively small amount with the promise of repayment when the borrower receives income from employment or other means at some point in the near future. Because there is a risk involved and the potential for low levels of reward on small amounts, payday loans typically have a relatively high-interest rate.
So, where did all this begin? And what is the history of payday loans?
Payday loans in the beginning
In ancient times, different civilisations had widely different approaches to lending and borrowing. In the 5th century, a system of borrowing that involved intermediaries, or brokers, emerged in North Africa and the Middle East. This system known as ‘Hawala’ provided swift loans between people based on a presumption of trust.
As the centuries progressed, religious temples began being operating a banking system of sorts. As they were often the most secure place in a community, temples were used to facilitate transactions and lending based on precious metals such as gold where it could be stored safely. And so, the systems of banking, financial transactions and exchanges of money continued to evolve.
Small scale lending in the 19th century
Small scale financial operators, known as ‘Salary Lenders’ appeared during the 19th century. The Industrial Revolution created a new type of worker – one paid regularly in instalments in return for their labour. This type of lender, who would loan cash until payday, sprung up in the towns and cities of the USA and spread to other countries, including Great Britain.
Sometimes such lenders were rather unscrupulous in their practices. Some even ‘shamed’ late payers by making their unpaid loans known publicly. Occasionally, extortion and threats of violence accompanied their attempts to recover ageing debts. As a result, governments and local policymakers would occasionally step in to license money lenders and attempt to stamp out dubious practices.
Meanwhile, philanthropic organisations would set about raising awareness of illegal loan providers – who became known as ‘loan sharks’. Such bodies would also offer loans themselves. The Cooperative movement and the Provident (‘the Provvie’) emerged in the UK and are well known as short term lenders to this day.
The 19th century was also notable for a fundamental shift in how financial transactions, including loans, were conducted. Before the advent of the railways and before people began to move across the country in large numbers, lending had tended to be a localised affair. This essentially ensured that borrowing was a relatively informal matter between people who, if they did not know each other personally, lived close to one another. In close-knit communities, lending of relatively small amounts did not necessarily require control, the establishment of contracts or regulation. In such situations, the lending of money tended to be based on trust.
As the railways opened up the country to long-distance exchanges of all manner of trade, so the same principles applied to finance and lending. Trust could not naturally be extended in such circumstances as it had at a local level. That meant the provision of loans became increasingly formalised with written terms and conditions attached to the transaction. A lot of the lending contract documents and indeed the language within them that we use today developed from this point onwards in history. It certainly explains why some of the terms in a payday loan contract nowadays sound pretty archaic to the modern borrower.
Into the Great Depression
Payday loans, as we now know them, evolved at a fast pace during the Great Depression of the late 1920s and 30s. Back then, banks didn’t tend to extend credit to consumers as they do now. Instead, lending facilities were pretty much only available to businesses.
To obtain a loan, people often had to rely on borrowing from friends and family. Depending on where they lived, folks could sometimes use a local cooperative society, a specialist money lending merchant or sometimes a department store that extended credit to customers.
Pawnshops were also an option. Having existed for centuries, legislation during the 1900s standardised how pawnshops operated by lending money secured against valuables. But, of course, the average person would need something valuable in the first place to be able to use them. And many ordinary working folks simply did not possess such a thing. The last resort would be the shadier section of society – or those loan sharks who continue to appear through financial history.
Something of a personal lending revolution began in the 1920s, accelerated during the prolonged economic turmoil of the Great Depression. Commercial banks began providing loans to individual consumers. At first, these tended to be the wealthier sections of society, but as economic pressures hit the lower-paid echelons particularly hard during this time, high street banks began lending to the less well off too.
Applicants would still need references and other documented evidence of creditworthiness, however. So for many, the traditional routes of friends, family, pawnbrokers and illegal lenders continued. The practice of extending credit against a post-dated cheque also continued to grow, driven by the financial insecurity of the times. This was effectively the payday loan market as we know it today.
Consumerism, consumer spending and consumer goods exploded midway through the 20th century, after the end of World War II. Much of this phenomenon can be attributed to the development of customer finance options. This included short term cash lending and buying items on credit to be repaid in instalments – i.e. ‘hire purchase’ agreements.
The popularity of extending credit for the purchase of relatively expensive household items is partly attributed to Issac Singer, the pioneer of the home sewing machine. Singer had experimented with credit options for his customers, and by the 1950s, it was commonplace for people to buy furniture, appliances, motor cars and even pianos on credit to repay in instalments. If the high street banks still tended to limit lending to the better-off sections of society, then hire purchase agreements enabled the less well off to acquire those things we now consider almost essential in modern life.
We should also recognise that relatively high-interest rates for ‘every day’ borrowing – be it for goods to be repaid in instalments or cash to be repaid on payday – were commonplace in the financial transactions of the mid 19th century. That trend continues to this day. Interest rates of above 20% were not uncommon for household lending of this type. Options to ‘roll-over’ instalment payments should the customer not be able to meet that month’s commitment also became increasingly widespread.
This credit-based economy enabled the poorer people to afford a lifestyle that they may otherwise have not been able to enjoy by making ‘payday become today’. Credit was also used by governments to stimulate demand, governments who had no desire to return to the recessions of the inter-war period that people still keenly remembered.
The first credit cards began being issued in America during the 1950s and 60s, with the rest of the world following close behind. The notion of ‘buy now, pay later’, which in essence is part of the reason that payday loans exist, was now firmly rooted and continues to this day.
Into the 1970s – cheque cashing
The practice of cheque cashing was not new by the 1970s but became increasingly popular as a form of borrowing during the decade. Essentially in this form of lending, the borrower exchanges a signed and dated cheque for ready cash. The lender cashes in the cheque at a predetermined repayment date – most obviously the date that their next salary instalment is due.
Cheque guarantee cards had been introduced in 1969. This offered assurances to lenders that they would still receive their money even if the cheque ‘bounced – i.e. there was insufficient cash in a borrower’s account to repay the loan.
The main problem with this form of borrowing is that the borrower doesn’t really have that much control over when the actual repayment is made. There is theoretically nothing to stop the lender from depositing the cheque at an earlier date than was agreed or later. Both instances can cause borrowers cash flow problems. By the 1980s and 90s, cash chequing as a form of borrowing had become less popular. The concept of payday loans emerged as a result.
The 1980s and 90s – mainstream payday lending emerges
In the 1980s, aided by increasing accessibility to banking services for all and new technologies, the payday loan industry emerged into the mainstream. Storefront payday loan lenders appeared on the high street. Customers could visit a payday loan shop with the required documents and gain access to relatively quick, small amounts of credit.
With the advent of the internet, payday loans became far more widely accessible. Web-based application systems meant that applicants could seek credit discreetly without having to physically visit a lending ‘shop’. The whole process could be completed in minutes and terms like ‘bad credit loans’ entered the financial vernacular.
Into the new millennium and the great payday loan reset
During the 2000s, and exacerbated by the global financial crisis of 2007-2008, there was an enormous boom in payday loan lending. The industry was regulated, but laws hadn’t entirely kept pace either with rapid advances in technology and the demand for small loans.
Many people began misusing payday loans, and some providers were heavily criticised. There was widespread alarm in the media at the high rates of interest and the problems caused by repeat business. Customers could access multiple payday loans at the same time, return to the same lender again and again, and debts quickly stacked up to unmanageable levels for those who rolled over their loans from one month to the next.
In the UK, in 2014, regulation of the payday loan industry was passed to the Financial Conduct Authority (FCA). Much stricter rules were introduced, and companies had to be re-authorised to trade in the payday loans markets to ensure they met the new robust regime. Affordability checks were made mandatory, and caps on interest rates and default fees were applied. Many payday loan companies opted to cease trading. Some collapsed. Some firms were forced to pay customers compensation where there was evidence of mis-selling or poor practice.
The industry that has been left in this wake is now a much more responsible one. Irresponsible lending and associated borrowing are far less likely to occur. Customers are also now much more aware of the purpose of a payday loan – as emergency access to cash that will cost more than other sources and must be repaid on time to avoid additional charges.
The premise of payday lending remains as it always has been throughout history. It can enable people to buy things that they need immediately with the loan to be repaid on their next payday. It also provides something of a safety net should the unexpected arise.
Accessing other forms of credit such as a bank loan or a credit card, even in these days of technological advance, is never near-instantaneous and typically takes days. By this point, a crisis situation can have escalated. Though payday loans got such bad press in their recent history has raised awareness of how they work and how they should work in a responsible manner. That cannot be a bad thing.