Payday loan

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

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. 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 (see cash advance). Legislation regarding payday loans varies widely between different countries and, within the USA, between different states.

Some jurisdictions impose strict usury limits, limiting the nominal annual percentage rate (APR) that any lender, including payday lenders, can charge; some outlaw payday lending entirely; and some have very few restrictions on payday lenders. Due to the extremely short-term nature of payday loans, the difference between APR and effective annual rate (EAR) can be substantial, because EAR takes compounding into account. For a $15 charge on a $100 2-week payday loan, the APR is 26 × 15% = 390% but the EAR is 1.1526 - 1 × 100% = 3686%. Careful reporting of whether EAR or APR is quoted is necessary to make meaningful comparisons.

Contents

[edit] The loan process

[edit] Retail lending

Borrowers visit a payday lending store and secure a small cash loan, with payment due in full at the borrower's next paycheck (usually a two week term). In the United States, finance charges on payday loans are typically in the range of 15 to 30 percent of the amount 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 postdated 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. The borrower is also required to provide recent bank statements.[citation needed] Individual companies and franchises have their own underwriting criteria.

[edit] 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.

[edit] 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 pay off or refinance the loan, the lender deposits the check.[1] In this example, the cost of the initial loan is a $60 finance charge, or 390% 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. [2]

[edit] Payday loans around the world

[edit] 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. [3] A OK charged its customers 21% interest, as well as a "processing" fee of C$9.50 for every $50.00 borrowed.[3] 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.[4] The British Columbia Court of Appeal unanimously affirmed this decision. [5]

Beginning November 1, 2009, payday loan regulations will be in force in British Columbia to cap the maximum charges for short term loans to 23% (including interests and fees), borrower can cancel the loan by the end of the following day of signing the agreement without paying any charge, only 1 loan per borrower at a time and to restrict the ability for lenders to access to borrower's bank or employer. All lenders will be required to register and regulated under the Business Practices and Consumer Protection Authority. [6]

[edit] UK

This section requires expansion.

The number of payday loans has grown in the UK recently: between August 2007 and June 2008, the number of loans made grew by more than 130%.[7]

Unlike in many US states, in the UK there is no prohibition on "rolling over" lending.[8] There does not seem to be a usury limit either: one UK company offers a "typical APR" of 1355%,[7] although this takes compounding into account; without compounding the APR would be 300%. Advertising of payday lending is subject to the Consumer Credit (Advertisements) Regulations 2004[9]. In particular, the "typical APR" must be stated in adverts which meet certain criteria, such as adverts which indicate that credit will be given to customers who may otherwise find access to credit restricted.[10]

There has been some criticism of these loans in the UK recently. Vince Cable MP said "The growing popularity of these loans highlights the problems stemming from the credit crunch and unsustainable levels of personal debt in the UK."[7]. Chris Tapp, of Credit Action, said in mid 2008: "Over the past year, payday loans have become an issue in the UK, and the growth in people who have problems who have such a loan has been notable in the last six months."[7].

[edit] U.S.

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.[11][dead link] 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, many states[12] have usury laws which forbid interest rates in excess of a certain APR. Some payday lenders have succeeded in getting around usury laws in some states by forming relationships with nationally-chartered banks based in a different state with no usury ceiling (such as South Dakota or Delaware). This practice has been referred to as "rate exportation", the "lender/servicer" model, or the "rent-a-bank" model. Under the legal doctrine of interest-rate exportation, established by Marquette Nat. Bank of Minneapolis v. First of Omaha Service Corp. 439 U.S. 299 (1978), the loan is governed by the laws of the state where the bank is chartered, regardless of the borrower's state of residence. 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.[13] 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 six payday loan renewals.[14] As a result, no federally insured banks engage in the business of payday lending as of 2007 using an agency model.

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. State laws in the United States generally preclude charging of fees other than those expressly permitted by law[citation needed], and the federal Truth In Lending Act requires disclosure of all fees.

Some states have laws limiting the number of loans a borrower can take at a single time[citation needed]. This is currently being accomplished by single, statewide realtime databases. These systems are required in Florida, Michigan, Illinois, Indiana, North Dakota, New Mexico, Oklahoma, and Virginia[citation needed]. These systems require all licensed lenders to conduct a real time verification of the customer's eligibility to receive a loan before conducting a loan. Reports published by state regulators in these states indicate that this system enforces all of the provisions of the state's statutes. Some states also cap the number of loans per borrower per year (Virginia), 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[citation needed]. Borrowers can circumvent these laws by taking loans from more than one lender if there is not an enforcement mechanism in place by the state. Some states allow that a consumer can have more than one loan outstanding (Oklahoma).

[edit] Federal regulation

In the US, although 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 a maximum of 36% APR as defined by the Secretary of Defense.[15] The Defense Department called payday lending practices "predatory", and military officers cited concerns that payday lending ruined low-paid enlisted men and women's finances, jeopardized their security clearances, and even interfered with deployment schedules to Iraq.[16]

Some federal banking regulators and legislators seek to restrict or prohibit the loans not just for military personnel, but for all borrowers,[17] because the high costs are viewed as a financial drain on the working and lower-middle class populations who are the primary borrowers.

Illinois Representative Luis Gutiérrez introduced the "Payday Loan Reform Act of 2009"[18] to the 111th Congress. The bill would greatly erode consumer protection as it claims to[nb 1] preempt state law.[18] If passed this bill would destroy state consumer protection and usury laws and provide Congressional approval to payday loans at rates of 780 percent APR.[19] The payday loan company QC Holdings[20] was Luis Gutiérrez's largest 2007-2008 election contributer[21][19]. The "C.L.E.A.R. Act"[22] submitted by California's Joe Baca April 1, 2009 is almost identical.[22]

[edit] 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,[23] which is the same maximum that banks and credit unions are capped at.[24][25] Payday lenders also must have a license from the District government in order to operate.[24] As a result of the interest-rate cap enacted by D.C., all licensed payday lenders have withdrawn from the market, and no lawful payday loans are presently available in D.C.

[edit] 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. [11][dead link]

[edit] 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[citation needed]58-15-33 NMSA 1978. 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. This is accomplished by verifying in real time against the approved lender compliance database administered by the New Mexico regulator. The statewide database does not allow a loan to be issued to a consumer by a licensed payday lender if the loan would result in a violation of state statute. A borrower's cumulative payday loans can not exceed 25 percent of the individual's gross monthly income.[26]

[edit] 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[citation needed]. 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[citation needed].

[edit] Controversy and criticism

Payday lending is a controversial practice and faces both legal battles and public perception challenges in nearly every place where it is practiced. In the UK, David Drew MP signed an early day motion criticizing the payday lending market for high APRs and for locking customers into a "cycle of credit dependency"; it also noted the growth of Dollar Financial, a US-based payday lending company trading as Moneyshop in the UK, and called for a public inquiry into the growth of high cost lending in general and payday lending in particular.[27]

[edit] Draining money from low-income communities

People who resort to payday lending are typically low-income people with few assets, as these are people who are least able to secure normal, lower-interest-rate forms of credit. Since the payday lending operations charge such high interest-rates, and do nothing to encourage savings or asset accumulation, they have the effect of depleting the assets of low-income communities.[28]

[edit] Exploiting financial hardship for profit

Critics such as Consumers Union 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, opponents of government regulation of payday loan businesses argue that some individuals that require the use of payday loans have already exhausted or ruined any other alternatives. Tom Lehman, an advocate of unfettered payday lending, said,

[P]ayday lending services extend small amounts of uncollateralized credit to high-risk borrowers, and provide loans to poor households when other financial institutions will not. Throughout the past decade, this "democratization of credit" has made small loans available to mass sectors of the population, and particularly the poor, that would not have had access to credit of any kind in the past....[29]

Lehman attacked proponents of increased regulation of the lending industry, arguing that,

These allegations against the payday-lending industry are largely without merit, and generally reflect the views of "do-gooder" anticapitalist elites who abhor the "messy" and unplanned outcomes in low-income consumer finance markets. Rather than seeing payday lending practices as a creative extension of credit to poor households who may otherwise be without loans, these critics see it as yet another opportunity for government intervention in the name of "helping" the poor.[29]

Lehman has in turn been criticized for presenting himself as an independent voice while taking money from the payday loan industry.[30]

[edit] Aggressive advertising practices

Debt charity Credit Action made a complaint to the UK Office of Fair Trading (OFT) that payday lenders were placing adverts on social network website Facebook which broke advertising regulations. Their main complaint was that the APR was either not displayed at all or not displayed prominently enough, which is clearly required by UK advertising standards. [31] [32]

[edit] Aggressive collection practices

In US 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[33]. This practice is illegal in many jurisdictions.

[edit] Ignoring legal restrictions

Payday lenders have been known to ignore usury limits and charge higher amounts than they are entitled to by law. On May 30, 2008, the Illinois Department of Financial and Professional Regulation fined Global Payday Loan $234,000—the largest fine in Illinois history against a payday lender—for exceeding the $15.50 per $100 limit on charges for payday loans.[34] A customer, known only as J.M., borrowed $300 and repaid $360 ($13.50 more than the company was legally entitled to collect under the Illinois Payday Loan Reform Act), but the company was still sending her warnings that her account was 'seriously delinquent' and that her unpaid balance was $630.

[edit] Pricing structure of payday loans

Issuers of payday loans defend their higher interest rates by saying processing costs for payday loans do not differ much from other loans, including home mortgages.[citation needed] 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[who?] 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 make a determination about the borrower's ability to pay back the loan.[citation needed]

[edit] Net profitability

A study by the FDIC Center for Financial Research[citation needed] 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".[35]

[edit] Proponents' stance

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.[36] "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." However, he also noted that loans are very expensive, and that they are likely to be made to under-educated households or households of uncertain income.

[edit] Variations and alternatives

[edit] Alternatives to payday loans

Other options are available to most payday loan customers.[37] These include pawnbrokers, credit union loans with lower interest and more stringent terms[38], 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.

[edit] 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[39][40], 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. A similar credit facility seen in the UK is a logbook loan secured against a car's logbook, which the lender retains.[41] 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.

[edit] See also

[edit] References

  1. ^ It is not clear nor is it even argued that payday loans are inter-state commerce which would give congress legislative authority.
  1. ^ a b CNN Money. A low, low interest rate of 396 percent
  2. ^ the Consumer Federation of America: Consumers Warned of Online Payday Loan Sites
  3. ^ a b Kilroy v. A OK Payday Loans Inc.
  4. ^ Kilroy v. A OK Payday Loans Inc., 2006 BCSC 1213 (2006).
  5. ^ Kilroy v. A OK Payday Loans Inc., 2007 BCCA 231 (2007).
  6. ^ GOVERNMENT MOVES TO REGULATE PAYDAY LENDERS
  7. ^ a b c d Gráinne Gilmore (2008-06-26). "Rise in payday loans show credit problems still to come". The Times (London). http://business.timesonline.co.uk/tol/business/economics/article4215193.ece. Retrieved on 2008-07-07. 
  8. ^ "Payday loans: Worrying trend?". Moneybox. BBC. 2003-09-13. http://news.bbc.co.uk/1/hi/programmes/moneybox/3106106.stm. 
  9. ^ "The Consumer Credit (Advertisements) Regulations 2004". Office of Public Sector Information, UK. http://www.opsi.gov.uk/si/si2004/20041484.htm. Retrieved on 2008-06-10. 
  10. ^ Ibid, secton 8.
  11. ^ a b Atlanta Journal-Constitution: Payday lenders hope to return in Georgia, 3/18/07[dead link]
  12. ^ http://apps.leg.wa.gov/Rcw/default.aspx?Cite=19.52&full=true
  13. ^ Text of Marquette Nat. Bank v. First of Omaha Corp. decision from Findlaw
  14. ^ FDIC's Revised Examination Guidance on Payday Lending
  15. ^ The John Warner National Defense Authorization Act - Talent Amendment
  16. ^ USA Today: Law caps interest on 'payday advances' to service members
  17. ^ Duprey, Rich. "Legislative Foes Shackle Payday Loans". Motley Fool. http://www.fool.com/investing/value/2007/01/31/legislative-foes-shackle-payday-loans.aspx. Retrieved on 2007-10-14. "The payday loan industry remains under assault at both the federal and state level." 
  18. ^ a b 11th - H.R. 1214
  19. ^ a b Colbert Report - Tuesday April 14, 2009, The Word (~6:30-9:30) [1]
  20. ^ Google Finance NASDAQ:QCCO - Summary
  21. ^ http://www.opensecrets.org/politicians/summary.php?cid=N00004874&cycle=2008
  22. ^ a b http://www.govtrack.us/congress/billtext.xpd?bill=h111-1846
  23. ^ "Special Feature: Payday Lenders to Comply With New Law: An Effective Consumer Protection Measure". District of Columbia Department of Insurance, Securities and Banking. December 18, 2007. http://newsroom.dc.gov/show.aspx/agency/disr/section/26/release/12328/year/2007. 
  24. ^ a b Jarrett, Jillian S. (2007-12-13). "Payday Lending Rules Tightened". The Washington Post. http://www.washingtonpost.com/wp-dyn/content/article/2007/12/12/AR2007121200991.html. Retrieved on 2008-01-20. 
  25. ^ Stewart, Nikita (2007-09-19). "Bill to Cap Payday Loan Interest Rates Passes". The Washington Post. http://www.washingtonpost.com/wp-dyn/content/article/2007/09/18/AR2007091801943.html. Retrieved on 2008-01-20. 
  26. ^ Forbes.com: NM Governor Signs Payday Lenders Bill
  27. ^ UK Parliament Early Day Motion 1280
  28. ^ [2] Howard Jacob Karger, "Scamming the Poor: The Modern Fringe Economy", The Social Policy Journal, pp. 39-54, 2004.
  29. ^ a b Lehman, Tom. "In Defense of Payday Lending." The Free Market. Mises Institute. Volume 23, Number 9. September 2003. [3]
  30. ^ This Opinion Brought To You By... Business Week, January 30, 2006
  31. ^ "Facebook users warned about ads". BBC News. 2008-05-12. http://news.bbc.co.uk/1/hi/uk/7395344.stm. Retrieved on 2008-06-10. 
  32. ^ Credit Action Campaigns on Facebook Debt Ads
  33. ^ Fast Cash Loans Charged by State Regulator
  34. ^ "Internet Payday Lender Fined More Than $230,000 for Unlicensed Lending In Illinois". Press release. Illinois. 2008-05-30. http://wwwc.illinois.gov/PressReleases/ShowPressRelease.cfm?RecNum=6001&SubjectID=1. Retrieved on 2008-06-11. 
  35. ^ U.S. House of Representatives Committee on Financial Services Democratic Office
  36. ^ "Defining and Detecting Predatory Lending", Federal Reserve Bank of New York Staff Reports, Number 273, January 2007
  37. ^ Times Dispatch: Other Options Exist[dead link]
  38. ^ "Breaking the cycle of payday loan 'trap'", USA Today, September 19, 2006
  39. ^ "New FDIC guidelines allow payday lenders to ignore state laws"
  40. ^ "Wells Fargo puts hold on direct deposit advance", bizjournal.com, June 2, 1997
  41. ^ "Decision of the Trade Mark Registry over "Log Book Loans"" (PDF). UK Intellectual Property Office. 2003-11-26. page 2. http://www.ipo.gov.uk/o37203.pdf. 

[edit] External links

[edit] Articles

[edit] Government resources

[edit] Industry reports

[edit] Organizations

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