Payday lending: a perfect solution or a perfect storm

0722_paydayloansBy Marty Denzer
Catholic Key Associate Editor

KANSAS CITY —Payday and title loan stores seem to crop up everywhere you look. There are at least 245 in Kansas City, 45 in St. St. Joseph, 32 in Maryville, 33 in Nevada and eight in Bethany, according to the online Yellow Pages. The latest licensing information, 2013-14, indicated that almost 900 payday loan stores are in operation at any one time in Missouri.

There are also an increasing number of parish-based emergency assistance programs and several Catholic social service agencies including Catholic Charities on both sides of the state line to help clients pay for rent, food and utilities, not because the recipients aren’t earning enough to pay these things themselves, but because the money they earn is going almost entirely to pay off payday or auto title loans. And due to the non-amortizing nature of payday loans in Missouri, often the amount paid bi-weekly by the borrower to the payday lender is interest and fees, with little or nothing going to pay down the principal.

You’ve seen the TV commercials — get the cash you need to help pay for emergency car repairs or medical bills!, all you need is a job and a bank account, no credit check!, get your title back!, and the like. For someone in financial straits, it sounds like the perfect solution. But wait. Instead of the perfect solution, a payday loan often turns into a perfect storm (a combination of high interest and fees, a short term: repayment due in two weeks or less, and other living expenses; individually each are not problematic, but occurring all together can produce a disastrous outcome). If the consumer didn’t have $500 to pay an emergency or recurring expense on one day, he or she most likely won’t have it to pay off the loan two weeks later. That’s when rollovers and taking out new loans to pay off old ones begin and, for many consumers, it’s like getting mired in quicksand. No matter how hard they struggle to get out, they just sink further in. That’s usury. And that’s profitable for the payday lender.

In Missouri, the maximum amount of a payday loan is $500, loaned over a period of two weeks to one month. The maximum finance rate and fees are not specified, although no borrower is required to pay a total amount of accumulated interest and fees in excess of 75 percent in any loan period. According to Missouri law, the finance charge of a 14-day $100 loan can be as much as $75 leading to an APR of 1950 percent, the highest allowed among states that have either banned or set APR caps on payday loan interest.

While there is nothing wrong with earning interest, usury has been decried for millennia. Old Testament books, including Exodus, Deuteronomy, Leviticus, Micah, Ezekiel and Proverbs forbade it and warned of God’s punishment to those who charged interest for loans of money or food to their countrymen. The Code of Hammurabi, the first codified laws written in Babylon nearly 1,800 years before Christ, banned usury. First Judaism, then Christianity and later Islam all denounced usury as exploitation of the poor.

Father Steve Cook, pastor of St. Peter’s and St. Therese Little Flower parishes, within whose boundaries are more than a dozen payday loan stores, said, “Throughout Scripture, we are called to raise people up, especially those in desperate need. Don’t kick people when they’re down.”

Plato and Aristotle condemned usury as immoral and unjust. The Greeks regulated interest, then deregulated it, creating so much debt that Athenians began to be sold into slavery to pay their debts and threatened revolt.

In 533 A.D., the Roman “Code of Justinian” set a graduated interest rate that capped at 8 1/3 percent for loans to ordinary citizens.

Roman law fined usurers at four times the amount taken while robbers were fined twice the amount taken. In the early 14th century, Dante wrote in his Inferno, that usurers were remanded to the lowest ledge of the seventh circle of hell, lower than murderers.

In 1570, during the reign of Queen Elizabeth I, interest rates in England were capped at less than 10 percent, a law that stood until 1854.

After 1776, the new American states adopt a general usury limit at 6 percent. Everything changed in the late 19th and early 20th centuries. A move to deregulate caused 11 states to eliminate their usury laws and nine others raised the usury cap to 10 – 12 percent.

In the late 19th century legal interest rates were low, which made small loans unprofitable. Such lending was also derided by society since the small loan borrower was seen as irresponsible, unable of managing a budget. Banks and major financial institutions wouldn’t touch a small dollar loan. There were plenty of fringe lenders who would touch small-time lending, however. This was the genesis of payday lending.

They were known as “salary lenders,” in other words, advancing a next paycheck to a borrower to repay the advance with their next paycheck. Salary lenders sought customers whom they considered good risks: steady and respectable employment which meant regular income and a reputation to protect, married, which meant the customer would be less likely to skip town, and whose motives for borrowing were legitimate.

Loan amounts and repayment plans were tailored to the borrower’s means, not necessarily to the borrower’s advantage. The smaller the loan the higher the interest rate, because the costs of tracking and pursuing a defaulter were the same whether the loan amount was big or small.
The attitudes of the lenders to defaulters varied also: some were reasonable, readily granting extensions, and slow to harass, while others tried to milk all they could from a borrower.

The latter, known as loan sharks, might threaten legal action against a defaulter. Since the loan and the contract weren’t legal, that was a bluff, but it worked. Others resorted to public shaming, exploiting the stigma of being a loan shark’s debtor. One ploy was to send agents to stand outside a defaulter’s home, denouncing him loudly to any and all passerby, even plastering his home with notices or graffiti. Whether the defaulter was embarrassed or just gullible, he usually paid up.

Whatever the trade was called — salary lending, loan sharking — it was a disreputable business. And owners often hid from public scrutiny by hiring managers to indirectly run the offices. When expanding to different cities, the owners would often open new firms under different names to avoid attracting unwanted attention. However, the penalties for illegal lending were pretty mild. It was a misdemeanor, and the punishment was forfeiture of the interest charged, and perhaps the principal. But that was only if the borrower sued, something he usually couldn’t afford to do.

0722_PaydayLOANS2Reputable businessmen and charities led the outcries against salary lending and by the mid-1910s, the Uniform Small Loan Law was first drafted. Enacted by 1916-17 in several states, it mandated consumer protections and capped the interest rate on loans of $300 or less at 3.5 percent monthly (about $142 annually if the loan was rolled over multiple times). The Uniform Small Loan Law was enacted in Missouri in 1927.

Some of the consumer protections included banning additional charges such as late fees. Lenders had to provide copies of all signed documents to the borrower. Such licensing laws made it impossible for a usurious lender to present himself as legal.

In addition, small dollar loans gained social acceptance and banks began to offer them. Then a new breed of illegal lenders, who used threats of violence to enforce debts, surfaced. Usually run by crime syndicates, such as the Mafia, these lenders generally served high risk borrowers including gamblers, thieves and financially strapped small businessmen who couldn’t qualify for a bank loan. Many lenders were former bootleggers who got into a new line of work after Prohibition was repealed in 1933. Threats of violence toward defaulters were more bark than bite, as injuring (or worse) a borrower could mean he would be unable to work and never able to pay off the debt. So future borrowing was cut off, a serious consequence for those who relied on fringe borrowing from loan sharks.

Close to home, in the 1930s, Kansas City area salary lenders began using postdated checks to evade usury and credit disclosure laws. By using customers’ personal checks, lenders could call themselves a check cashing service or that the check was an IOU, rather than disclose being a payday lender.

In 1935, it was found that although Missouri’s Uniform Small Loan Law lacked certain recent improved provisions, was still reasonably effective in practice due either to vigorous supervision and enforcement or active self-regulation by licensed small loan lenders. Kansas at that time still had no Uniform Small Loan Law in effect.

Between 1945 and 1979, all 50 states had adopted special loan laws that capped the interest rates at 36 percent, a rate higher than the general usury rate but still capped.

In the 1980s, state regulators sought to end schemes to lend money in violation of state usury laws. Interest rates were set to enforce against predatory and abusive lending. Missouri legislators had for decades limited interest rates on small loans. Then in 1991, the legislature granted small dollar lenders an exemption from the usury laws, making high cost lending practices legal in the state.

Less than a decade later, the Missouri Legislature in 1998 wiped out the usury cap, thus allowing unlimited interest rates across a range of credit products. That same year, the legislature authorized car title loans, where car titles serve as collateral. The majority of payday lenders operate out of small storefronts on street corners or in strip malls.

In a 2011 demographic study of payday lending, the FDIC, which insures banks and other depository institutions, found that African American and Hispanic families, recent immigrants and single parents (usually moms) were more likely to use payday loans. In addition, use of such loans was not, as the industry suggests, for emergency or one-time expenses, but to meet normal, recurring obligations, such as housing, utilities or car payments.

Jump to 2016. Research findings of the Consumer Finance Protection Bureau, a federal agency established in 2010 by the Dodd-Frank Act, pretty well describe the situation in the 27 states that allow payday lending, including Missouri, and the nine states that allow payday lending with restrictions.

According to CFPB, the median fee on a storefront payday loan is $15/$100 borrowed, and the average loan term is 14 days, which results in an annual percentage rate of 391 percent on a $350 loan. If the loan is indeed paid off within 14 days, the fee/interest is $52.50. A similar Federal Trade Commission example calculated a $100 loan with an initial interest of $15. The APR would be 391 percent if the loan is rolled over every 14 days. With just three rollovers the finance fee amounts to $60 to borrow $100.

Storefront payday lenders reported about $3.6 billion in revenue from interest and fees in 2015. Two thirds of the loans are made to borrowers whose fee expenses exceed the amount they borrow; in sequences of seven or more loans in a row. The CFPB estimated that in the 36 states allowing some type of payday lending there were 15,766 such stores, while across all 50 states in 2014, there were 14,350 McDonald’s restaurants.

More than 80 percent of payday loans are rolled over or reborrowed. In a study tracking payday borrowers over a 10-month period, it was found that four out of five loans were rolled over or reborrowed within 30 days, racking up additional fees each time.

Payday borrowers default about 20 percent of the time, either on the first loan or after reborrowing. Nearly 50 percent of the defaults occur after the third reborrowing. Late payments and defaults can incur penalty fees from the lender as well as additional bank fees if fees and payments cause other checks to bounce.

Consumers receiving monthly benefits are most likely to fall into a long-term debt trap: senior citizens and those receiving disability, Social Security and other federal benefits. Some borrowers have remained in debt as long as one to five years.

Twenty five states allow auto title lending. Seven allow only single payment title loans. Thirteen states permit a single payment or an installment loan and five allow installment loans only. The CFPB found that single payment auto title loans have a high rate of default and one in five borrowers have had their vehicle seized by the lender for non-payment. Auto title installment loans have high rates (more than 30 percent, often after refinancing at least once) of default and repossession.

In 2006, Congress had passed the Talent Amendment, sponsored by Senator Jim Talent (R-MO), capping the interest on loans made to active military personnel and their families at 36 percent. In 2014, the Military Lending Act was updated to better protect military families from predatory lending, retaining the 36 percent interest rate cap.

According to research in 2012 by the PEW Charitable Trusts, there are three categories of states with payday loan regulations. Permissive states, including Missouri, are the least regulated. They allow initial fees of 15 percent of the principal borrowed or higher. There is some regulation in most of the states but they still allow for loans payable on the borrowers’ next payday with APRs of 391 to 521 percent ($15 to $20/$100/ borrowed over two weeks). Payday loan stores are easily accessible to borrowers, and about 55 percent of Americans live in the 28 permissive states. Even permissive states have areas where payday lending is restricted. Independence, Mo., only allows payday loan stores that were in business before 2013. Mayor Eileen Weir took office in April 2014. She said that other than those grandfathered-in stores, no new such operations are permitted. A 2013 residential survey showed that most of the check-cashing and payday lending outlets had disappeared.

Hybrid states, are somewhat more exacting in their requirements for payday lending. About 16 percent of Americans live in the eight hybrid states. Restrictive states do not permit payday lenders or have rate/fee caps low enough to make it unprofitable for such lenders, generally 36 percent, the same as for military borrowers. These states either do not authorize post-dated checks, have specific laws on usury or explicitly prohibit payday lending by state statute. As a result, usually there are no payday loan stores in the state. While that doesn’t preclude a consumer going online and seeking an online payday loan or going to a nearby state that permits them, the restrictions serve to keep such lenders from expanding into those states. Twenty-nine percent of Americans live in the 14 restrictive states and the District of Columbia.

Proponents of payday lending argue that they are providing a service to those who either cannot qualify for a bank loan or have run into an emergency, such as a medical expense or car repair. They say that the fees are in line with the costs. They say that the majority of borrowers are satisfied with the loan and the lenders and would borrow again. Interestingly, payday lenders usually don’t ensure that a borrower can repay the loan within the stated time period (usually 14 days) and still be able to pay other living expenses including housing, utilities and food.

The Missouri Legislature has not joined other states in taking action to either prohibit or severely restrict payday lending. More than five years ago, the Better Business Bureau concluded that “weak payday loan laws have attracted major out-of-state lenders,” such as QC Holdings in Overland Park, Kan., “to engage in predatory lending, costing Missourians who can least afford it millions of dollars a year.” And nothing has changed, yet.

In early June, the CFPB announced proposed rules affecting the payday loan industry. Payday lenders would be compelled to verify a borrower’s ability to repay a loan; the number of times a loan could be rolled over, with new fees and interest, would be limited to two and, that after two failed debit attempts on a borrower’s bank account, a lender would be required to reach out to the borrower to seek another means of payment, thus helping to keep a borrower out of a “debt trap.”

The proposed rules are in the middle of a 90-day consumer question/comment period. These rules don’t require Congressional approval, and could go into effect as early as September.

To learn more or comment on the proposed rules, visit www.consumerfinance.gov.

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  • Remmo

    The Church is doing good work to provide financial assistance to people in need. However, we can not keep pace with the demand the send people to payday lenders, While I have no love for the payday lenders, I do believe we need to focus instead on the circumstances driving people to them. Whenever I hear the number of payday loans compared to places like McDonalds, I always think about how much a fast food worker is paid–often not enough to support a family. If we can make an impact on raising wages for the same people we are providing alms to, we’d go much further in helping them out.

Sunday
September 25, 2016
Newspaper of the Diocese of Kansas City ~ St. Joseph