There have been plenty of reports about the higher monthly payments that many subprime borrowers and other homeowners will face when the teaser rates on their adjustable-rate mortgages are "reset" to market levels.
Other articles have focused on the double-digit interest rates that millions of credit-card holders already pay for the convenience of buying and borrowing with plastic.
In both cases, however, the costs of borrowing pale in comparison to what another group of lenders (hint: they are not the guys who break your legs) is able to extract from those who apparently have nowhere else to go.
In "A Low, Low Interest Rate of 396 Percent," CNNMoney.com reports on an extortionate but nevertheless generally legal and increasingly popular financing arrangement.
Struggling Cleveland homeowners are taking out payday loans when they fall short. Is it a quick source of cash or legalized loan sharking?
At the East Side Organizing Project in Cleveland, six home owners recently went in for group foreclosure counseling. When asked if any had taken out payday loans, four hands shot up.
A payday loan is a small-dollar, short-term loan with fees that can add up to interest rates of almost 400 percent. They're generally taken out when the borrower is caught short on cash and promises to pay the balance back next payday.
If it sounds like legal loan-sharking, it's not. "Loan sharks are actually cheaper," said Bill Faith, a leader of the Ohio Coalition for Responsible Lending.
The industry portrays it as emergency cash, but critics say the business model depends on repeat borrowing where the original loans are rolled over again and again.
They're available in 41 states, but they've been particularly troubling in Ohio, one of the states hit hardest by home foreclosures.
"There may be a correlation between not having the means to pay mortgages and payday loan borrowing," said republican state legislator William Batchelder, at a Thursday press conference held with the Center for Responsible Lending (CRL). Batchelder is sponsoring a bill that would cap payday loan interest rates at 36 percent.
Jim Rokakis, treasurer of Cuyahoga County, which includes Cleveland, said, "I've been to [foreclosure counseling] sessions where almost everyone raised their hands," saying they had payday loans.
One ESOP client said, "You get a payday loan and you take your pay next payday and pay back the loan. Then you don't have enough money to last to the next payday, so you go back. If you don't pay the loan, they call everybody from your employer to your sister."
Faith said he saw a sign in the window of a payday lending shop that read: "The first loan is free." The business evolved from check-cashing services. In Ohio, the number of lender locations jumped from 107 in 1996 to 1,562 10 years later.
"If you want to see what an unregulated market economy looks like," said Rokakis, "come to Ohio." There are now more payday lending shops in the state than McDonalds, Burger Kings and Wendy's restaurants combined, he noted.
Lenders only require borrowers show pay stubs, checking accounts and references. They don't credit-check, except to make sure borrowers haven't defaulted on previous payday loans.
The lenders ask borrowers for post-dated checks for the amount borrowed, plus fees, which average $15 per $100 loan. If the loan goes un-repaid, lenders deposit the checks.
The term is usually two weeks, "Most people believe they're just going to borrow the one time," said Faith. Instead, when the two weeks goes by, they often go back to the shop and roll it over for another two weeks. To do that, they pay another $45 in fees.
"It's not a two-week loan," said Uriah King, of the CRL. "Most loans are rolled over 10, 12 or 13 times. That's the business model even though the industry says it's not."
When the CRL took the average payday loan principal as reported by state regulators and multiplied it by the average number of loan rollovers per year, it found that typical borrowers pay back $793 for a $325 loan.
At least 10 million households get payday loans over the course of a year, according to the CRL. Borrowers are disproportionately minority, female and in the military. They have lower income and education levels than the general population.
Not everyone agrees that payday lending bad. "People are not complaining, CRL is complaining. Go to any state consumer complaint agency and you'll find very few about payday lending," said Steven Schlein of the Community Financial Services Association, a payday lending group.
A paper by Donald Morgan, a research officer with the Federal Reserve Bank of New York, indicates that payday lending may be preferable to some alternatives. In two states where it was banned, he found, consumers were worse off.
They're more likely to bounce checks, he found, which is more expensive than payday loans. Fees on bounced checks can carry an annual percentage rate of 1,000 percent.
But King believes that's a false comparison. "People don't knowingly bounce checks," he said. It's usually an accident, and it's illegal. "How do you take a payday loan to avoid bouncing a check?" he asked.
Most consumers who get caught short have much cheaper alternatives to payday loans, according to the CRL. Many have credit cards that could provide them with cash advances with much lower interest. Others have access to credit union loans, pay advances at work or home equity loans. Debtors can also work out delayed payments plans with creditors.
Federal and state governments have started to take aim at the industry. Last year Congress passed legislation capping interest rates on consumer loans for military personnel at 36 percent. North Carolina and Georgia have both ended payday lending. Other states like Ohio are discussing remedies like Batchelder's bill.
But the CRL doesn't believe changing state laws to fix payday lending is enough. "We've concluded that this is a defective product," said King, "that can't be reformed."
To be fair...
http://www.fool.com/personal-finance/credit/2007/11/16/battling-for-payday-loans.aspx
When my Foolish colleague Selena Maranjian extolled the virtues of banning payday loans for members of the military, I knew it was because she wants consumers to run their financial lives Foolishly. After all, living from paycheck to paycheck and making regular use of short-term loans is not a particularly wise use of one's financial resources.
Yet I've found the cap on payday loan rates to the military -- which effectively amounts to a ban on those loans entirely -- to be a shortsighted measure that diverts attention from the real problem: inadequate pay for our soldiers.
Credit drying up
It's hard to argue that you should be a habitual user of payday loans, at least if you ultimately want to be financially secure. As a stopgap measure, they have their place if you are in a tight spot, but short-term loans with easy qualification criteria end up costing far more when they are used for long-term needs. Yet payday loans have been singled out for congressional action, while other sources of "fast cash" are still permitted. And they come with their own problems.
For example, credit card cash advances are relatively accessible forms of debt. Cash advance checks usually come attached to your monthly statement, but they typically carry higher interest rates than purchases, offer no grace period, and come with a cash advance fee. Interest piles up immediately. Further, if you carry a balance on your credit card, any payments you make are typically applied first to your lower-rate debt, resulting in higher interest rates and total costs. And as bad as these terms may be, if you have bad credit, you might not have access to cash advances or have a credit card at all.
Perhaps tapping your home equity sounds like a better way to get low-interest cash. Well, it was until recently. Now we see that it's not just the borrowers at the low end of the FICO scale who are defaulting on their mortgages -- those with better credit are having trouble paying, too. Many supposedly responsible lenders touted the benefits of using a home's equity like a private bank -- and homeowners have seen it come back to bite them.
We could also talk about the relatively low interest rate you could get on a straight bank loan for a few hundred dollars -- except that small bank loans have pretty much disappeared. That's one of the reasons behind the proliferation of payday lending services: Traditional financial institutions have largely abandoned micro-loan customers. Even for more sizeable loans, if you don't have a bank account or a verifiable credit record, you won't be getting any cash, either.
The last stop
In reality, for the poor, the cash-strapped, and those who can't build strong banking relationships, few alternatives are available. Payday lenders are about the only financial institutions willing to make small loans. Advance America (NYSE: AEA), for example, the largest payday lender in the country with more than 2,900 financial centers, offers loans from $50 to $1,000 and charges a fee ranging from 10% to 22% depending on the loan's size.
It's true that a $15 fee for a $100 loan means you'll pay hundreds in fees if you keep rolling it over. But trying to translate those fees to an APR is misleading. When banks charge $3.50 or more to get money out of an ATM, you may not realize that you could easily pay $175 or more in fees every year just by using a cash machine once a week. And when a bank charges $29 for bouncing a $10 check, you don't typically see it referred to as charging 290% interest for a one-day "loan." The same holds for late fees on credit cards. All financial institutions make huge amounts of money on fee income -- not just payday lenders.
It's true that payday lenders have been very profitable of late. Cash America (NYSE: CSH) and First Cash Financial (Nasdaq: FCFS) both reported a 31% increase in net income this past quarter, while EZCORP 's (Nasdaq: EZPW) profits were up 22%. But these are high-risk loans that require no credit check and offer quick turnarounds. As lenders of last resort, these companies' fees are higher, but without those fees, their profit margins would disappear and they'd go out of business, leaving borrowers without any solutions at all.
The fact is, while we wish individuals would always be Foolish with their finances, life intrudes, and the ability to make it to the next payday requires a short bridge loan. Traditional financial institutions have abandoned customers with this need, whether they are civilians or military personnel. Now Congress has effectively removed even this stopgap measure for members of the military.
As is usually the case, it's far more politically expedient for Congress to attack a symptom than a cause. As we reflect on those soldiers who sacrifice their lives in service to their country, let's consider how we can do more for them -- instead of narrowing the options they have available.
Posted by: Transplanted | December 17, 2007 at 03:27 PM