Payday Loan!
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As legislation advances in Congress to crack down on consumer-unfriendly lending practices, staffers in the offices of California Sens. Barbara Boxer and Dianne Feinstein noticed a funny thing this week: Customers of payday lenders were calling by the hundreds to oppose the bill, and all seemed to be repeating the exact same phrases.
The staffers were right to be suspicious.
Payday lenders are notorious for their high fees and interest rates, and they may face new restrictions as part of efforts to overhaul the financial services industry and create a Consumer Financial Protection Agency.
Yet customers of these companies were calling to demand that government authorities leave the industry alone and allow consumers to make their own financial decisions. They said they wanted Boxer and Feinstein to vote against the reform legislation.
"My offices were getting hundreds of calls from the same few phone numbers, and the callers all seemed to be reading from the same script," Boxer told me. "What was most surprising was that the callers were opposing a bill that was designed specifically to protect them."
She said her office had received more than 900 calls as of Thursday.
Gil Duran, a spokesman for Feinstein, said his office had received only a handful of calls, but they mirrored those received by Boxer.
"It seemed that the callers were being asked to do this," he said. "It seemed unusual."
It was. The outpouring of ostensibly spontaneous consumer rage was in fact a well-orchestrated effort on the part of the payday-lending industry to sway the vote on financial reform.
It was also an extraordinary application of pressure on a vulnerable segment of the community: people with high-interest loans who could be financially devastated if the issuers of those loans suddenly demanded their money back.
David Lazarus
You know you're in trouble when you have to pay your Visa bill with your Master card!
Payday Loan
A payday loan or paycheck advance is a small, short-term loan that is intended to cover a borrower's urgent expenses until their next payday. Typical loans are between $100 and $1500, are usually on a 2 week term, and usually have interest rates in the range of 390 percent to 900 percent (annualized). They are also sometimes referred to as cash advances, though that term can also refer to cash provided against a prearranged line of credit such as a credit card.Though payday lending is primarily regulated at the state level, the United States Congress passed a law in October 2006 that will cap lending to military personnel at 36% APR. The Defense Department called the lending "predatory", and military officers cited concerns that payday lending exacerbated soldiers' financial challenges, jeopardized security clearances, and even interfered with deployment schedules to Iraq.
Some federal banking regulators and legislators seek to restrict or prohibit the loans not-just for military personnel, but for all borrowers, because the high costs are viewed as an unnecessary financial drain on the lower and lower-middle class populations who are the primary borrowers.
Lenders point out that these loans are often the only option available to consumers with bad credit who have urgent expenses and cannot get a bank loan, credit card, or other lower-interest alternative. Critics counter that most borrowers find themselves in a worse position when the loan is due than they were when they took the loan, with many getting trapped in a cycle of debt.
The industry's fast paced growth indicates a highly profitable business model. Statistics show that the majority of the industry's profit comes from repeat borrowers, who are unable to pay them off on the due date and instead repeatedly renew their loans, paying fees each time.
Payday Loan Process
Borrowers visit a payday lending store and secure a small cash loan, usually in the range of $100 to $500 with payment in full due at the borrower's next paycheck (usually a two week term). Finance charges on payday loans are typically in the range of $15 to $30 per $100 borrowed, which translates to rates ranging from 390 percent to 780 percent when expressed as an annual percentage rate (APR). The borrower writes a post-dated check to the lender in the full amount of the loan plus interest and fees. On the maturity date, the borrower is expected to return to the store to repay the loan in person. If the borrower doesn't repay the loan in person, the lender may process the check traditionally or through electronic withdrawal from the borrower's checking account.If the account is short on funds to cover the check, the borrower may now face a bounced check fee from their bank in addition to the costs of the loan, and the loan may incur additional fees and/or an increased interest rate as a result of the failure to pay.
Payday lenders generally do little due diligence to assess a borrower's ability to repay a loan, but many do require the borrower to bring one or more recent pay stubs to prove that they have a steady source of income.
Most payday borrowers are not able to repay their loans loan in full at their first paycheck, and will renew (or "flip") the loan, which is the practice of renewing a loan at maturity by paying additional fees without any principal reduction.
Payday lenders typically operate small stores or franchises, but large financial service providers also offer variations on the payday advance. See below: "Variations on Payday Lending".
Payday Loan Example
For example, a borrower seeking a payday loan may write a post-dated personal check for $460 to borrow $400 for up to 14 days. The payday lender agrees to hold the check until the borrower's next payday. At that time, the borrower has the option to redeem the check by paying $460 in cash, or renew the loan (a.k.a. "flip the loan") by paying off the $460 and then immediately taking an additional loan of $400, in effect extending the loan for another two weeks. If the borrower does not refinance the loan, the lender may deposit the check. In this example, the cost of the initial loan is a $60 finance charge, or 390% percent APR. If the borrower chooses to renew the loan three times, the finance charge would climb to $240 to borrow $400.Payday Loan Summary of the Lending Market
The Payday loan industry has an annual loan volume of more than $28 billion. It is a quickly growing industry. Estimates from the year 2000 put loan volume at between $8 and $14 billion, indicating that the market has more than doubled in size in 6 years. 91 percent of their revenue comes from borrowers who cannot pay off their loans when due, rather than from one-time users dealing with short-term financial emergencies.Only one percent of payday loans go to borrowers who take out one loan per year and walk away free and clear after paying it off. The typical payday borrower pays back $793 for a $325 loan.
Payday Loan Controversy and Criticism
Payday lending is a controversial practice and faces both legal battles and public perception challenges in nearly every state.Payday Loan Exploiting Financial Hardship For Profit
Critics blame payday lenders for exploiting people's financial hardship for profit. Lenders target the young and the poor, particularly those near military bases and in low-income communities. Borrowers may not understand that the high interest rates are likely to trap them in a "debt-cycle", where they have to repeatedly renew the loan and pay associated fees every two weeks until they can finally save enough to pay off the principal and get out of debt. Critics point out that payday lending unfairly disadvantages the poor, compared to the middle class who pay at most 25% or so on their credit cards.However, most individuals that require the use of payday loans have already exhausted or ruined any other alternatives. The Consumer Federation of America would have you believe that there are other alternatives available to these consumers but when asked during a recent conference call with the Center for Responsible Lending, their position was they should borrow from relatives, friends, etc. The issue here is that most of these consumers are not poor, only poor money managers and therefore have most likely burned the bridge with friends and family.
Payday Loan Aggressive Collection Practices
In many instances the payday lender can use aggressive collection practices that include threatening criminal prosecution for writing a bad check despite the fact that lenders routinely accept post-dated checks drawn on accounts that have insufficient funds.Payday Loan Industry Claims Inflate Loan Costs
Defenders of the higher interest rates note that processing costs for payday loans do not differ much from their higher-principal, longer-term counterparts such as home mortgages. They argue that conventional interest rates at these lower dollar amounts and shorter terms would not be profitable. For example, a $100 one-week loan, at a 20% APR (compounded weekly) would generate only 38 cents of interest, which would fail to match loan processing costs.Critics counter that payday lenders' processing costs are significantly lower than costs for mortgages and other traditional loans. Payday lenders usually look at recent pay-stubs, whereas larger-loan lenders do full credit checks and other due diligence when making a determination about the borrower's ability to pay back the loan.
Payday Loan Lenders Overstate the Industry's Risks
A study by the FDIC Center for Financial Research found that operating costs lie in the range of advance fees collected and that, after subtracting fixed operating costs and unusually high rate of default losses, payday loans may not necessarily yield extraordinary profits. Based on the annual reports of publicly traded payday loan companies, loan losses can average 15% or more of loan revenue. Underwriters of payday loans must also deal with people presenting fraudulent checks as security or making stop payments.Critics concede that some borrowers may default on the loans, but point to the industry's pace of growth as an indication of its profitability. Consumer advocates condemn the practice as a whole, regardless of its profitability, because it "takes advantage of consumers who are already hard-pressed to pay their debts".
Payday Loan Lenders Overstate the Industry's Risks
Many believe that payday loans are the only option for consumers with bad credit, but other options do exist and most financial counselors would direct people to explore the alternatives. Other options are available to most payday loan customers.Payday Loan Other options include
Credit unionsCredit payment plans
Paycheck cash advances from employers
Overdraft protection
Cash advances on credit cards
Emergency community assistance plans
Small consumer loans
Direct loans from family or friends
Ignoring the options above, payday lenders make the argument that the interest on a payday loan is less than the costs associated with bounced checks or late credit card payments. For example, bouncing a $100 check may incur an NSF fee from the bank of $28 and a returned check fee of $25 from the merchant. Critics counter that these other kinds of fees are exceptions, whereas the fees on a payday loan are a regular and repeating cost.
Payday lenders present their product's terms alongside a very different list of alternatives and associated fees (costs expressed here as APRs for two-week terms):
$100 payday advance with $15 fee= 391% APR;
$100 bounced check with $48 NSF/merchant fees = 1,251% APR;
$100 credit card balance with $26 late fee = 678% APR;
$100 utility bill with $50 late/reconnect fees = 1,304% APR.
Payday Loan Neutral consumer information
The Canadian federal government publishes a booklet called The Cost of Payday Loans which compares the costs of borrowing the same amount of money using various credit products, including a payday loan. The booklet also explains how payday loans work and the many fees and charges that can apply. It is published by the Financial Consumer Agency of Canada.Payday Loan Regulation and Legislation
Regulation of lending institutions is handled primarily by individual states, and this growing industry exists atop an active and shifting legal landscape. Lenders lobby to enable payday lending practices, while opponents of the industry lobby to prohibit the high cost loans in the name of consumer protection.The U.S. Congress recently approved a provision capping loans to military personnel at 36% APR. The Defense Department report said the average military borrower pays $827 on a $339 loan and called the lending "predatory". Military officers pushed for the law, saying the loans saddled low-paid enlisted men and women with debts that ruined their finances, jeopardized security clearances and left them unable to deploy to Iraq or other assignments. The provision was signed into law by President Bush on 2006-10-17, and will take effect on 2007-10-01.
Payday lending is legal and regulated in 37 states. In Georgia and 12 other states, it is either illegal or not feasible, given laws on the books. When not explicitly banned, laws that prohibit payday lending are usually in the form of usury limits: hard interest rate caps calculated strictly by APR.
In the United States, most states have usury laws which forbid interest rates in excess of a certain APR. Payday lenders have succeeded in getting around usury laws in some states by forming relationships with banks chartered in a different state with no usury ceiling (such as South Dakota or Delaware). This practice has been referred to as "Rate exportation", the "agency model" and the "rent-a-bank" model. Under the legal doctrine of rate exportation, established by Marquette Nat. Bank v. First of Omaha Corp. 439 U.S. 299 (1978), the loan is governed by the laws of the state the bank is chartered in. This is the same doctrine that allows credit card issuers based in South Dakota and Delaware states that abolished their usury laws to offer credit cards nationwide. As federal banking regulators became aware of this practice, they began prohibiting these partnerships between commercial banks and payday lenders. The FDIC still allows its member banks to participate in payday lending, but it did issue guidelines in March 2005 that are meant to discourage long term debt cycles by transitioning to a longer term loan after 6 payday loan renewals.
For usury laws to be effective, they need to include all loan fees as part of the interest. Otherwise, lenders can charge any amount they want as fees and still claim a low interest rate.
Some states have laws limiting the number of loans a borrower can take at a single time. Some states also cap the number of loans per borrower per year, or require that after a fixed number of loan-renewals, the lender must offer a lower interest loan with a longer term, so that the borrower can eventually get out of the debt cycle. Borrowers often circumvent these laws by taking loans from more than one lender.
Payday Loan Regional Legislation
Payday Loan Withdrawal from North Carolina
On March 1, 2006, the North Carolina Department of Justice announced the state had negotiated agreements with all the payday lenders operating in the state. The state contended that the practice of funding payday loans through banks chartered in other states illegally circumvents North Carolina law. Under the terms of the agreements, the lenders will stop making new loans, will collect only principal on existing loans and will pay $700,000 to non-profit organizations for relief.Payday Loan Banning in Georgia
Georgia law prohibited payday lending for more than 100 years, but the state was not successful in shutting the industry down until the 2004 legislation made payday lending a felony, allowed for racketeering charges and permitted potentially costly class-action lawsuits.Payday Loan Regulation in New Mexico
New Mexico will cap fees, restrict total loans by a consumer and prohibit immediate loan rollovers, in which a consumer takes out a new loan to pay off a previous loan, under a new law that will take effect on 11/1/2007. A borrower who is unable to repay a loan will automatically be offered a 130-day payment plan, with no fees or interest. Once a loan is repaid, under the new law, the borrower must wait 10 days before obtaining another payday loan. The law will allow the term of a loan to run from 14 to 35 days, with the fees capped at $15.50 for each $100 borrowed. There also will be a 50-cent administrative fee to cover costs of lenders verifying whether a borrower qualifies for the loan, such as determining whether the consumer is still paying off a previous loan. A borrower's cumulative payday loans could not exceed 25 percent of the individual's gross monthly income.Payday loans in Canada
According to the Canadian Criminal Code, any rate of interest charged above 60% per annum is considered criminal. On August 14, 2006, the Supreme Court of British Columbia issued its decision in a class action lawsuit against A OK Payday Loans. A OK charged its customers 21% interest, as well as a "processing" fee of C$9.50 for every $50.00 borrowed. In addition a "deferral" fee of $25.00 for every $100.00 was charged if a customer wanted to delay payment. The judge ruled that the processing and deferral fees were interest, and that A OK was charging its customers a criminal rate of interest. The payout as a result of this decision is expected to be several million dollars. The British Columbia Court of Appeal unanimously affirmed this decision.Federal legislation passed in the spring of 2007 transferred regulatory authority on payday loans to the provinces.
Payday Loan Proponents Stance
Although some view payday loans as predatory or even loan sharking that target low-income clients, proponents are adamant that payday loans provide a service that is not available from many national banks. Many banks do not offer small, short-term loans and these payday loans fill a niche in the economy. Many cities across the United States are implementing ordinances on the manner in which payday loan centers conduct business. Economic studies show that consumer credit, even at very high rates of interest, is generally welfare-enhancing.A staff report released by the Federal Reserve Bank of New York concluded that a payday loan should not be categorized as "predatory" since they may improve household welfare. The working paper, "Defining and Detecting Predatory Lending," reports that "if payday lenders raise household welfare by relaxing credit constraints, anti-predatory legislation may lower it." The author of the report, Donald P. Morgan, defined predatory lending as "a welfare reducing provision of credit." Results of the report indicated that payday loans may actually do the opposite by improving the welfare of the consumer.
Payday Loan Variations on Payday Lending
Payday Loan Direct Deposit Advance
Some mainstream banks offer advances for customers whose paychecks or other funds are deposited electronically into their accounts. A customer requesting a "direct deposit advance" receives a predetermined cash advance amount that is deducted, along with a fee (usually around 10%-20% of the amount borrowed), when the next direct deposit is posted to the customer's account.Payday Loan Refund Anticipation Loans
Income tax preparation firms including H&R Block partner with lenders to offer "refund anticipation loans" to filers; such loans are not technically payday loans (because they are repayable upon receipt of the borrower's income tax refund, not at his next payday), but they have similar credit and cost characteristics.Payday Loan Internet Lending
Online payday loans are marketed through e-mail, online search, paid ads, and referrals. Typically, a consumer fills out an online application form or faxes a completed application that requests personal information, bank account numbers, Social Security Numbers and employer information. Borrowers fax copies of a check, a recent bank statement, and signed paperwork. The loan is direct deposited into the consumer's checking account and loan payment or the finance charge is electronically withdrawn on the borrower's next payday. The Consumer Federation of America conducted a survey of 100 Internet payday loan sites showed that loans from $200 to $2,500 were available, with $500 the most frequently offered. Finance charges ranged from $10 per $100 up to $30 per $100 borrowed. The most frequent rate was $25 per $100, or 650% annual interest rate (APR) if the loan is repaid in two weeks.Payday Loan Neutral Government Information
The Canadian federal government publishes a booklet called The Cost of Payday Loans, which explains how payday loans work and the various fees and charges that can apply. The publication also illustrates the cost of borrowing using a payday loan, compared to the cost of borrowing the same amount using other credit products. The booklet is published by the Financial Consumer Agency of Canada.
