Why are payday loans so popular with the military?

Editor’s note: A version of this first appeared on Javelin Strategy & Research’s blog.

Short-term lending products bridge a financial gap for their users, but the rates that lenders charge — and sometimes obscure as fees — can verge on predatory. Most consumers avoid these products, but active members of the military seem to embrace them.

For those who are enlisted, they have some protections under the law. The Military Lending Act, which was first enacted in 2006, addresses predatory lending. That law also goes above and beyond the Consumer Financial Protection Bureau’s rule designed to stop payday debt traps, which has yet to go into effect. But considering how popular these products are with active-duty military personnel, one has to wonder if the existing law has just encouraged a bad financial practice.

Regardless of the product, usage rates of short-term loans and other alternative financial products are incredibly high among active duty members of the military — despite a concerted effort by the U.S. armed forces to promote fiscal responsibility and deter their active duty members from obtaining short-term lending products. At Javelin Strategy & Research’s blog, we’ve found 44% of active duty military members received a payday loan last year, 68% obtained a tax refund loan, 53% used a non-bank check-cashing service and 57% used a pawn shop — those are all extraordinarily high use rates. For context, less than 10% of all consumers obtained each of those same alternative financial products and services last year.

Why is this happening? At least part of this phenomenon can be attributed to age as those in the military tend to be young and Gen Y consumers are generally higher adopters of these services because they are earlier in their financial lives — earning less income and in possession of less traditional forms of credit.

But those conditions don’t tell the whole story. With the explosion of digital financial services, a lack of accessibility doesn’t explain these differentials. Is there something more? Why are these products so attractive to a segment of the population with a very regular paycheck? It could be a function of unintended consequences.

Military members have some protections from the predatory aspect of short-term loans. The Military Lending Act was enacted to address predatory lending, similar to the CFPB’s recent regulations on short-term lending. One area where the Military Lending Act goes beyond the bureau’s regulations is specifically in setting limits on one of the most criticized aspects of short-term lending: the interest rate. The act caps the interest rate lenders can charge military members to just 36% for products like tax refund loans and payday loans. The intent of the act was to prevent companies from shackling the U.S. military with loans while they were overseas — an outcome that could induce stress and hamper their ability to focus. But even at the interest-rate cap, military members are still paying high rates — the kind of rates that are typically reserved for consumers with bad credit.

Considering that so many members of the active military are younger and may lack established credit, the question becomes: Has the act legitimized these products for members of the active military, and as result, actually driven usage higher than it would be otherwise? And is that delaying progress toward obtaining mainstream financial products with more favorable terms?

It is possible. Consider that the rates military members pay to use these services as a result of the act are not all that much higher than a thin- or no-file consumer could expect to pay on more traditional types of products, such as credit cards. As a result, there is less incentive to engage with traditional credit and loan products if they don’t have strong, established credit. Unfortunately, using these types of short-term loan products does not help military members build a positive credit history.

With financial fitness being such an important factor to our military, it is evident that more must be done to not only encourage good financial habits, but to build a pathway to the use of more traditional financial products. In doing so, active-duty members of our military will more quickly gain access to fairly priced financial products. Over time, that will help them avoid falling into a short-term lending trap that could extend far beyond their service.

James Wilson contributed to this article.