Virginia's State Employee Loan Program has a downside

payday loans signIn an op-ed piece (subscription required) in the Wall Street Journal, Virginia governor Tim Kaine explains a new loan program being offered to state employees: the Virginia State Employee Loan Program, "a unique partnership between the Virginia State Employee Assistance Fund and the Virginia Credit Union."
Here's how it works: state employees can borrow anywhere from $100 to $500 at an APR of 24.99% -- the loans are repaid via automatic withdrawals from the employees' paychecks over a six-month period. There are no prepayment penalties, and employees can only have one loan out at a time and no more than two loans per 12-month period.

I applaud Governor Kaine for his innovative approach to providing an alternative to payday loans -- which generally come with fees that can equate to an APR rate of 300% or higher. Kaine writes that "The results of the Virginia State Employee Loan Program suggest that if individuals are offered an alternative to predatory loans, they take it. Just six months into the initiative, Virginia has already issued 2,794 loans to state employees, totaling $1,373,400. Nearly half of these loans -- 1,310 -- came during the first month of the program's existence."

If these loans were only being made to people who were about to take out a payday loan, this would be a great program and a great argument for such a program. My concern is that by marketing loans at 24.99% APR to state employees, a significant number of people who wouldn't otherwise be borrowing money are seizing the opportunity to go into debt when they have better alternatives.

Put another way, providing clean needles to intravenous drug abusers to prevent the spread of HIV might be good public policy. But providing drugs and clean needles to non-users might slow the spread of HIV with the devastating side effect of increasing the number of intravenous drug users.

In looking to reduce the number of people taking out ultra high-interest payday loans, the state of Virginia should take care to ensure that it doesn't increase the number of people taking out high-interest loans: 24.99% is a high-interest rate and it is very, very hard to build wealth borrowing money at that interest rate.

If Virginia can find a way to ensure that the loans are targeted exclusively at people who would otherwise take out payday loans (i.e. by standing outside payday loan stores and offering the loans), this could be a hugely valuable program. Otherwise, it may well do more harm than good, however noble its intentions.
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