Preying on financially insecure
State must toughen laws on payday-loan, check-advance firms
Lexington Herald-Leader, September 26, 2005
By Jonathan Harrison
Caught between paychecks?
Short on cash?
Pre-approved in minutes!
No credit check.
We're here for you--borrow $200 today, payback $202.
If you haven't heard the ads, surely you've seen the storefronts. Take a stroll down Main Street Kentucky (from rural towns to city center) and there they are: payday lenders.
Our state is home to 650-plus payday lenders, also known as check advance or fast cash shops. And due to a combination of bad policy and legal loopholes, both their number and the dollars they lend are growing like kudzu.
Payday lenders make small cash "advances" in exchange for holding personal checks for future deposit, usually the borrower's next payday. But since a two week "loan" with $17 finance charges per $100 lent would violate the state's usury laws, the practice is considered instead as a "deferred deposit transaction."
The industry is rife with such euphemisms. It offers "convenient check cashing," "emergency cash flow" and a "smart alternative to bouncing checks and credit card late fees" for people "who are denied access to credit by traditional lenders."
But consider these facts provided by the Center for Responsible Lending in Durham, NC:
• Payday loans cost triple-digit interest rates, typically 390 to 780 percent annually.
• Payday loan interest rates are on average 400 percent higher than credit card interest rates.
• The average borrower takes eight to 13 loans out from a single lender and a total of 14 to 22 loans out each year.
• Payday lenders make $40 billion in loans and collect $6 billion in finance charges from borrowers each year in the U.S.
• Payday loans cost American families $3.4 billion every year.
To qualify for a payday loan, all a borrower needs is a bank account and a source of income or benefits. This is why the industry notoriously preys on the military and people on (or transitioning off of) government assistance. The ability to repay the loan is not assessed through a credit check, as with bank loans.
Instead, payday lenders entice cash-strapped consumers to write checks without funds on deposit. Two weeks later, the borrower is still short on cash, and visits another payday lender to float the first loan (aka "loan flipping").
Conveniently, payday lenders can acquire multiple licenses for "different" companies within the same state. In effect, a borrower can wrack up hundreds of dollars of fees to extend the term of the loan without ever paying off the principle. This is the debt trap.
Payday lending is not growing because of increased consumer demand, but because payday lenders get their steady customers to take out more loans.
Ninety-one percent of payday loan borrowers take out more than five payday loans a year, and one Kentucky payday lender reports that 70 percent of his company's loans are paid back via another payday loan.
A single loan for the first-time borrower to cover surgery, bridge the gap between jobs, or buy Christmas presents quickly turns into a merry-go-round of additional loans and hundreds of dollars in fees each month.
Meanwhile, the lender has it made, and here's how: with little risk or investment (a pledge of a $50,000 CD, according to the Kentucky statute) a computer and a couple of desks, the business is born.
In a three-month period, the shop develops a user group of 200 customers. This modest customer base generates $18,000 per month on an average check size of $250. And the payday lender nets from $12,000 to $14,000 per month in operating profit.
Payday lending is predatory lending. Straight and simple. A business model that targets the cash-strapped, charges big fees on small loans, and encourages loan flipping is one that traps people in debt for years.
And whether or not we engage in such transactions, we help pay for them. We all pick up the tab when people can't afford food, rent, and health care, and we're all chipping in for the skyrocketing personal bankruptcy rates.
A Georgia law passed in 2004 prescribes harsh felony penalties for lenders who make loans of $3,000 or less in violation of existing lending and consumer protection laws.
The law caps interest rates of small consumer loans at 60 percent per year, the state's small-loan usury rate. Other states have capped overdraft and bounced check fees to prevent outrageous effective interest rates.
There are alternatives to payday lending, including credit counseling, employer based payroll advance programs, and assisting the un-banked in starting direct deposit accounts at community development credit unions.
Within a few months after a new member joins, most credit unions will write small loans to members who direct deposit their checks.
Kentucky has laws that are supposed to protect consumers. We need to make these laws stronger. The state cannot afford to allow cash strapped people to get sucked into a whirlpool of deeper and deeper debt. Tougher legislation is the guardrail needed to keep the unwary from going over the edge.
Jonathan Harrison is business development director of Mountain Association for Community Economic Development in Berea.