Wikipedia

Payday loan

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A payday loan (also called a paycheck advance or payday advance) is a small, short-term loan that is intended to cover a borrower's expenses until his or her next payday. Typical loans are between $100 and $500, on a two-week term and have interest rates in the range of 390 percent to 780 percent (APR)[1]. The loans 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.

A shop window in Falls Church, Virginia advertises payday loans.

Though payday lending is primarily regulated at the state level, the United States Congress passed a law in October 2006 becoming effective on Oct. 1, 2007 that caps lending to military personnel at 36% APR as defined by the Secretary of Defense.[2] The Defense Department called payday lending practices "predatory", and military officers cited concerns that payday lending exacerbated soldiers' financial challenges, jeopardized security clearances, and even interfered with deployment schedules to Iraq. [3]

Some federal banking regulators and legislators seek to restrict or prohibit the loans not just for military personnel, but for all borrowers,[4] 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 say these loans are often the only option available to consumers with bad credit or who cannot get a bank loan, credit card, or other lower-interest alternatives. Critics counter 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 compiled by the Center for Responsible Lending show that the majority of the industry's profit comes from repeat borrowers who are unable to repay loans on the due date and instead repeatedly renew their loans, paying fees each time.[5]

The loan process

Retail lending

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 for the two-week period, which translates to rates ranging from 390 percent to 780 percent when expressed as an annual percentage rate (APR)[1] The borrower writes a check to the lender in the full amount of the loan plus 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. For customers who cannot pay back the loan when due, members of the national trade association are required to offer an extended payment plan at no additional cost. In states like Washington, extended payment plans are required by state law.

Payday lenders require the borrower to bring one or more recent pay stubs to prove that they have a steady source of income. They are also required to provide recent bank statements. Individual companies and franchises have their own underwriting criteria.

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 number 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.

Examples

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. In many states, "flipping" or "rolling over" the loan is not allowed. In states where there is an extended payment plan, the borrower could choose to opt into a payment plan. 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.

When the Consumer Federation of America conducted a survey of 100 internet payday loan sites, it found 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. [6]

Payday loans in Canada

According to the Criminal Code of Canada, 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.[7] The British Columbia Court of Appeal unanimously affirmed this decision. [8] Federal legislation passed in the spring of 2007 transferred regulatory authority on payday loans to the provinces.

U.S. 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.

Payday lending is legal and regulated in 37 states. In Georgia and 12 other states, it is either illegal or not feasible, given state law.[9] 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.[10] 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.[11]

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.


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.

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. [9]

Regulation in New Mexico

New Mexico caps fees, restricts total loans by a consumer and prohibits immediate loan rollovers, in which a consumer takes out a new loan to pay off a previous loan, under a law that took effect November 1, 2007. A borrower who is unable to repay a loan is automatically 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 allows the term of a loan to run from 14 to 35 days, with the fees capped at $15.50 for each $100 borrowed. There is also 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 can not exceed 25 percent of the individual's gross monthly income.[12]

Regulation in the District of Columbia

Effective January 9, 2008, the maximum interest rate that payday lenders may charge in the District of Columbia is 24 percent, which is the same maximum that banks and credit unions are capped at.[13][14] Payday lenders also must have a license from the District government in order to operate.[13]

Controversy and criticism

Payday lending is a controversial practice and faces both legal battles and public perception challenges in nearly every state.

Exploiting financial hardship for profit

Critics blame payday lenders for exploiting people's financial hardship for profit. They say lenders target the young and the poor, particularly those near military bases and in low-income communities. They also say that 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 also say that payday lending unfairly disadvantages the poor, compared to the middle class who pay at most 25% or so on their credit cards.

However, supporters argue that some individuals that require the use of payday loans have already exhausted or ruined any other alternatives. This argument assumes the victim would not have considered better alternatives earlier on had the payday loan not been available in the first place. Payday lenders argue that a bank's overdraft fees, which often are $25 or more per instance, can be much more costly than the $15-30 per hundred dollars borrowed from an abusive lender.

Aggressive collection practices

By law, a payday lender can use only the same industry standard collection practices used to collect other debts.

In many cases, the borrower has written a post-dated check to the lender; if the borrower defaults, then this check will bounce. Some payday lenders have therefore threatened delinquent borrowers with criminal prosecution, for check fraud[15]. This practice is illegal in many jurisdictions and has resulted in regulatory action.

Pricing structure of payday loans

Defenders of the higher interest rates say processing costs for payday loans do not differ much from other loans, including home mortgages. They argue that conventional interest rates for 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 say 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 making a determination about the borrower's ability to pay back the loan.

Net profitability

A study by the FDIC Center for Financial Research found “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".[16]

Proponents' stance

Proponents claim that cash advance loans provide a service that is not available from other sources, without regard to whether or not the alleged "service" was in the best interests of the victim and should have been offered or not. Many credit unions have attempted to offer similar products, but have been unable to do so without government subsidies or grants, a fact that many lenders and reports have highlighted. Furthermore, most of these programs offered by credit unions have ended due to the high default rates of borrowers.[citation needed]

A staff report released by the Federal Reserve Bank of New York concluded that payday loans should not be categorized as "predatory" since they may improve household welfare.[17] "Defining and Detecting Predatory Lending" reports "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."

Morgan's posit regarding payday loans hinges precariously on the "if" question of "raising household welfare" in such circumstances, without further exploration of the ramifications of continued reliance on usurious sources of credit.

Variations and alternatives

Alternatives to payday loans

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.[18] Other options are available to most payday loan customers.[19] These include pawn shops, credit union loans with lower interest and more stringent terms[20], credit payment plans, paycheck cash advances from employers, bank overdraft protection, cash advances from credit cards, emergency community assistance plans, small consumer loans and direct loans from family or friends.

Payday lenders do not compare their interest rates to those of mainstream lenders. Instead, they compare their fees to the overdraft, late payment, and penalty fees that will be incurred if the customer is unable to secure any credit whatsoever.

The lenders therefore list a different set of alternatives (costs expressed here as APRs for two-week terms):[citation needed]

  • $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.

Variations on payday lending

A minority of mainstream banks offer advances for customers whose paychecks or other funds are deposited electronically into their accounts. The terms are similar to those of a payday loan; a customer receives a predetermined cash credit available for immediate withdrawal. The amount is deducted, along with a fee, usually about 10 percent of the amount borrowed, when the next direct deposit is posted to the customer's account. After the programs attracted regulatory attention[21][22], Wells Fargo called its fee "voluntary" and offered to waive it for any reason. It later scaled back the program in several states.

Income tax refund anticipation 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. A car title loan is secured by the borrower's car, but are available only to borrowers who hold clear title (i.e., no other loans) to a vehicle. The maximum amount of the loan is some fraction of the resale value of the car. These loans may be available on slightly better terms than an unsecured payday loan, since they are less risky to the lender. If the borrower defaults, then the lender can attempt to recover costs by repossessing and reselling the car.

See also

References

  1. ^ a b CNN Money. A low, low interest rate of 396 percent
  2. ^ The John Warner National Defense Authorization Act - Talent Amendment
  3. ^ USA Today: Law caps interest on 'payday advances' to servicemembers
  4. ^ Duprey, Rich. "Legislative Foes Shackle Payday Loans". Motley Fool. Retrieved 2007-10-14. The payday loan industry remains under assault at both the federal and state level.
  5. ^ "Financial Quicksand: Payday lending sinks borrowers in debt with $4.2 billion in predatory fees every year", Center for Responsible Lending
  6. ^ the Consumer Federation of America: Consumers Warned of Online Payday Loan Sites
  7. ^ Kilroy v. A OK Payday Loans Inc., 2006 BCSC 1213 (2006).
  8. ^ Kilroy v. A OK Payday Loans Inc., 2007 BCCA 231 (2007).
  9. ^ a b Atlanta Journal-Constitution: Payday lenders hope to return in Georgia, 3/18/07
  10. ^ Text of Marquette Nat. Bank v. First of Omaha Corp. decision from Findlaw
  11. ^ FDIC's Revised Examination Guidance on Payday Lending
  12. ^ Forbes.com: NM Governor Signs Payday Lenders Bill
  13. ^ a b Jarrett, Jillian S. (2007-12-13). "Payday Lending Rules Tightened". The Washington Post. Retrieved 2008-01-20.
  14. ^ Stewart, Nikita (2007-09-19). "Bill to Cap Payday Loan Interest Rates Passes". The Washington Post. Retrieved 2008-01-20.
  15. ^ Fast Cash Loans Charged by State Regulator
  16. ^ U.S. House of Representatives Committee on Financial Services Democratic Office
  17. ^ "Defining and Detecting Predatory Lending", Federal Reserve Bank of New York Staff Reports, Number 273, January 2007
  18. ^ The Toledo Blade: Local payday lenders cash in on rising short-term needs
  19. ^ Times Dispatch: Other Options Exist
  20. ^ "Breaking the cycle of payday loan 'trap'", USA Today, September 19, 2006
  21. ^ "New FDIC guidelines allow payday lenders to ignore state laws"
  22. ^ "Wells Fargo puts hold on direct deposit advance", bizjournal.com, June 2, 1997

Articles

Government resources

Industry reports

Organizations

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