For hundreds of thousands of the most vulnerable Americans, the continuous payday advance cycle has created an environment of debt and desperation. The lure of “quick, easy cash” has drawn many into a never-ending chain of high-interest loans to “float” payments on a loan they were unable to afford in the first place.
Take, for example, Andrew from North Carolina (names were changed to protect the identity of the portrayed). Andrew, at 69, was a warehouse worker living a comfortable life surrounded by his adult children and his grandchildren. At the time, he was building an addition on his home so that his daughter could set up her own beauty shop.
Out of curiosity, after visiting his local grocery store, he saw an offer from an Advance America store offering cash advances. When he asked the clerk what he needed for an advance, he was told just a bank account, an income and a driver’s license. There were no attempts to ascertain his current financial obligations, his ability to pay the loan or his long-term financial health — in all, he was told he could walk out with his money in just 15 minutes.
Andrew wrote a personal check that Advance America would use as collateral, and accepted the cash. He realized only five years later that he had stepped into a trap.
Two weeks later, when his loan payment was due, Andrew realized that he needed his paycheck for weekly expenses. The lender was not interested in accepting installments on the loan, so Andrew found himself in danger of default. Because the lender had a signed check from Andrew as collateral, there was a danger that the principal would be withdrawn from Andrew’s account automatically — compounding the situation — or that the check would bounce and incur even more penalties. The clerk assured Andrew that he could renew the loan if he paid a $35 fee to avoid default. Because this fee did not apply to the principal, Andrew still owed $200 plus interest.
Andrew became what is known in the payday lending industry as a “26er” — a borrower who came in every payday to pay a fee to avoid defaulting on his original loan. In Andrew’s case, the arrangement resulted in an annual fee of $910 on a $200 loan. So, each payday, Andrew extended his loan and paid the $35.
Andrew saw it as a plus — he was able to access his paycheck earlier, when he needed the money. Even though the principal on the loan went up to $295 — which meant the default payment went up to $50 — he was willing to pay for the convenience.
Eventually, the toll of making these payday payments caught up to him, and Andrew failed to keep up on his mortgage payments. Forced into bankruptcy, Andrew realized the horrible truth about his payday loan: Over five years, he paid nearly $5,000 for the $200 he originally borrowed.
While Andrew’s story is extreme, it is not uncommon. The Center for Responsible Lending estimates that payday lending costs American borrowers over $3.4 billion per year.
The payday lending industry
A group of U.S. senators are pushing federal officials to prevent Federal Reserve-regulated financial institutions from engaging in payday lending.
In a Jan. 2 letter to the comptroller of the currency and the heads of the Federal Reserve and Federal Deposit Insurance Corporation, the senators illustrate a disturbing trend: Payday lending is not solely the domain of small storefronts and strip-mall stores, but also of major banks.
“The banks call these loans deposit ‘advance’ loans, but they are structured just like loans from payday loan storefronts, carrying a high cost (averaging 365% in annualized interest) combined with a short-term balloon repayment (averaging just 10 days),” the letter reports. “Like non-bank payday borrowers, bank payday borrowers routinely find themselves unable to repay the loan in full while meeting their expenses the next month without taking out another payday loan,” the letter continued. “On average, bank payday borrowers are stuck in this debt cycle for 175 days per year. The typical borrower takes out 16 bank payday loans within twelve months, with many borrowers taking out 20 or even 30 or more loans within one year.”
The letter was signed by Sens. Richard Blumenthal (D-Conn.), Dick Durbin (D-Ill.), Charles Schumer (D-N.Y.), Sherrod Brown (D-Ohio) and Tom Udall (D-N.M.).
“Consumers who utilize non-traditional credit resources would defend their actions by saying they had no choice, and often that may be true,” said Gail Cunningham, vice president of membership and public relations for the National Foundation for Credit Counseling, in an interview with Mint Press News. “When emergencies occur, if unprepared to resolve the issue through savings, and without access to traditional lines of credit, their options narrow. Desperate people resort to desperate measures, often unaware of the cost of their decision.”
“Consumers need to be educated about the costs associated with these types of services,” Cunningham continued. “They may be well-intentioned, thinking the loan will be a one-time event. However, often the loans are rolled over multiple times. The ‘easy money’ often comes with triple-digit interest rates. A better solution is to find the root of the problem and work to resolve it. Is the cause a lack of income? Overspending? Financial mismanagement? Job loss? Medical? As difficult as it may be, facing the problem sooner rather than later is always better than delaying action.”
The economic realities of payday lending are real and acute. According to a March report from the Insight Center for Community Economic Development, payday loans were permitted in 33 states in 2011. In those states that year, the practice cost the American economy $774 million and more than 14,000 jobs, the Insight Center said.
These losses are due to a decrease in household spending, caused by an annual interest rate in excess of 400 percent for this type of lending. For the $3.3 billion in interest payday lenders collected in 2011, $6.4 billion in household spending was taken out of the national economy, while only $5.6 billion in payday lending spending was returned. The net impact is a loss of 24 cents per interest dollar to the economy
Combined with the cost of the related 56,250 Chapter 13 bankruptcies, payday lending cost the American economy nearly $1 billion in 2011, the Insight Center said.
According to data collected by the Pew Charitable Trusts, the average payday loan is $375. Those most likely to take a payday loan are those without a four-year college degree, home renters, African Americans, those with an annual income of $40,000 or less and those that are separated or divorced. The average amount that borrowers can afford to repay on these loans is only $100 a month.
Currently, over 22,000 locations nationwide originate an estimated $27 billion in annual payday loan volume, according to the Center for Responsible Lending. With default fees amounting to $3.5 billion per year and with the “churning” of existing two-week loans amounting to three-fourths of the payday loan volume, the exploitation of those that can not afford this type of lending is big business.
The realities of “easy money”
“I spent over $1200 in fees for a $255 ‘revolving’ cash loan,” said “Carol,” who ultimately took out 35 payday loans between August 1998 and January 2000. “I was throwing away $90 in fees every month just to use the same $255 cash payday loan. And, worst of all, I had no idea how this trap worked until I was out from under it.”
“I didn’t even realize the payday-lending trap until my mother found out that this was how I was getting what I thought was extra money,” “Carol” continued. “Once she explained to me how these places do more harm than good, I was almost relieved, because then I understood why I was more broke than I was before the payday loans; my bills were now further behind and I was stressed out.”
While the Federal Reserve is hesitant to call this type of banking “predatory,” it can be abusive — as it targets those most in need of “quick money” and subjects them to heavy interest rates and unaccommodating repayment terms. While the industry’s trade group — the Community Financial Services Association of America — has recommended best practices to curb the abuse attributed to the industry, the notion and proliferation of this subset of banking in America underlies hard truths about poverty in this nation.
“There are a number of shorter-term and revolving consumer credit products for low- and moderate-income customers, such credit cards, personal loans, home equity lending, pawn brokering, refund anticipation loans and ‘Tony Soprano’ lenders,” Joe Giglio, a professor at Northeastern University’s D’Amore-McKim School of Business, told Mint Press News via email. “For sure, some of the products are outside of the regulatory environment. The reputation of this segment of the financial services industry is not closely identified with transparency and fairness. Also, for these customers, borrowing against your retirement account like a 401(k), marketable securities or insurance policies are not readily available.”
Giglio argued that, for less-than-creditworthy groups, credit is hard to attain and needlessly expensive when achieved.
“Perhaps,” Giglio said, “consideration should be given to creating not-for-profit lending institutions to work with low-income loan customers and provide financial literacy like the micro lending that takes place in emerging countries, offering these customers opportunities to make minimum payments to avoid damage to their credit records.”
Regulating payday lending
Payday lending is currently banned by nonbank institutions in the states of Arizona, Arkansas, Connecticut, Delaware, Georgia, Massachusetts, New Hampshire, New Jersey, New York, North Carolina, Ohio, Oregon, Pennsylvania, Vermont, West Virginia and the District of Columbia.
Colorado, Florida, Maine, Minnesota, Oregon, Rhode Island, Virginia and Washington state allow payday loan storefronts, but have laws limiting fees and interest rates or allowing for longer repayment periods.
In April, the Office of the Comptroller of the Currency and the FDIC issued a 21-page guidance notification to its member banks, seeking to cease the usage of payday or advance lending and forcing banks to assess the ability to repay loans before granting them. The proposal would also introduce a mandatory 30-day “cooling-off” period between loans, clear disclosure of interest rates on all loans, and marketing changes that describe payday advances as loans.
More than a dozen groups — including the National Consumer Law Center and the NAACP — applauded the proposal. FDIC Chairman Martin Gruenberg said in a statement that it “reflects the serious risks that certain deposit advance products may pose to financial institutions and their customers.” However, many banks that offered these loan products defend their actions.
“Our Checking Account Advance gives customers access to funds for use in case of an emergency, with transparent pricing, as well as limits, safeguards and cooling-off periods built in to help customers avoid becoming overextended,” said Tom Joyce, spokesman of Minneapolis-based U.S. Bank, in an e-mail to the Minneapolis Star-Tribune. He indicated that 96 percent of the customers that used the service were satisfied.
Well Fargo, U.S. Bank, Bank of Oklahoma, Guaranty Bank, Fifth Third Bank and Regions Bank directly offer payday loans to its customers, while Bank of America, Wells Fargo and JPMorgan Chase have permitted payday lenders to withdraw funds by payday lenders from bank customers accounts, even in states such as New Jersey and New York, where payday lending is explicitly banned by law. JPMorgan Chase has indicated in March, however, that new practices have been installed that will give its customers more power to halt payday loan withdrawals and close their accounts while pending payday loan charges are attached to it.
“We took a look at our policies and decided to make a number of changes,” said Ryan McInerney, CEO of Consumer Banking at Chase, as reported from a Chase press release. “Some customers agree to allow payday lenders or other billers to draw funds directly from their accounts, but they may not know some of the aggressive practices that can follow. Those practices include repeated attempts for payment that can result in multiple returned items. We don’t believe these practices are appropriate, and are making these changes to help protect customers from unfair and aggressive collections practices.”
Breaking the cycle
“Despite the fragmented banking regulatory environment at the federal level (all are members of the post Dodd-Frank Financial Stability Oversight Council), Congress and the Fed has tried to pass legislation dealing with unexpected interest rate increase, unfair billing practices, and excessive fees,” Giglio said. “While consumer advocate groups — such as the Consumer Federation of America — are in favor of these measures, the banking industry has successfully opposed regulatory and legislative proposals, arguing that these changes would result in higher card fees and reduced access to credit to accommodate the credit risks of subprime borrowers. They have a large lobbying playbook.”
It is being realized that this type of lending is being used as a credit strategy for recurring expenses, despite the perception that payday lending is being used as relief in emergency situations. This is troubling, as — with a 400 percent APR — payday lending is the costliest fiduciary instrument available.
Pew has illustrated that in spite of intervention by the Fed, states are the most effective measure towards regulating the payday lending market. “To date, payday loans have been regulated primarily at the state level,” Pew’s report, “Payday Lending in America: Who Borrows, Where They Borrow, and Why,” states. “Pew’s findings show that states that have chosento implement statutory controls on these products have been successful in realizing policy makers’ goal of curbing payday lending, with 95 out of 100 would-be borrowers electing not to use payday loans rather than going online or finding payday loans elsewhere. These findings are particularly important as policy makers discuss what happens to payday borrowers when storefront lenders are not present because of regulatory action.”
Ultimately, the borrower, too, must participate in the breaking of this cycle of abusive lending. As has been said before, if someone is willing to buy, he will find someone willing to sell. However, change is afoot. Many payday lenders offer payment plans or adhere to the CFSA’s “best practices” policy of extending an emergency payment plan for borrowers that have difficulty paying. New ventures are also emerging to tackle the question of “sub-prime” lending.
One of these ventures is ZestCash. ZestCash — which is now known as Spotloan — launched in 2012 in Utah, Idaho, Missouri and South Dakota, allowing borrowers to choose the amount they wish to borrower, the length of the loan period and the exact weekly payments they wish to make. “We believe all data should be credit data,” says Douglas Merrill, founder and CEO of ZestCash. “By using ‘big data’ analytical techniques we are able to offer a fair, lower cost alternative to people who do not have access to traditional credit.”