Missouri has made headlines recently, because citizens have signed petitions to get an initiative placed on the November ballot to cap interest rates of payday loan businesses at 36%. This would be a substantial reduction in the interest rates that are currently charged, and not surprisingly, the well-funded lobby of the payday loan industry has launched their own campaign to try and defeat the measure. Taking the matter to court, they have managed to get a judge to rule that the petition was “likely to deceive voters.” Ironic, given that the terms of payday loans are often deceptive to those who find themselves in the unfortunate position of needing the cash. Equally mind-bending are the names of the groups opposing the ballot initiative, Missourians for Equal Credit Opportunity and Missourians for Responsible Government. One doesn’t have to wonder much if these groups count among their “members” people who have paid over 700% interest for their loans.
Lawmakers at both the state and city level are slowly starting to act against the long-ignored practice of predatory lending to lower income people, with some states prohibiting them altogether. Recently, news was made that San Jose, California would become the largest city in the country to cap the number of payday loan businesses in their city at 38. This doesn’t do anything about the outlandish interest rates that these establishments charge to their desperate clientele, but it does seek to rein in their unchecked proliferation. Just how bad has it gotten? In Missouri, a state where action to address predatory lending may well be blocked, there are far more payday lenders (with about 1,275 of them) than there are McDonalds and Starbucks combined. One bizarre feature of Missouri’s payday loan industry is that even nursing homes in the state have licenses to loan to their employees and then deduct the loan from the employee’s next paycheck. According to a report by the Better Business Bureau of St. Louis, in 1996, there were roughly 2,000 payday loan businesses across the country. By 2008, that number had grown to a stunning 22,000. And why not? There is next to nothing more profitable than gouging people with interest rates that can go as high as 911% for a one-week loan; 456% for a two-week loan, and 212% for a one-month loan. Indeed, the industry makes an estimated $33 billion dollars annually.
Payday loan businesses have been allowed to operate unchecked by legislation for years, although individual states have taken small steps toward regulating the industry. Loans are offered for periods anywhere between a week and a month with 80% of payday loans being made for less than $300. Payday lenders don’t do credit checks unlike banks (although banks have begun to get into the payday loan business), so people with debt problems are allowed to access funds. Their customers, some 5% of the US population, are invariably people who are either badly in debt or frantically in need of money due to their meager incomes. They usually live paycheck-to-paycheck from low-wage jobs, and according to economist Michael Stegman, they typically must show proof of employment demonstrating income of at least $1000 per month at the time of the loan, although other forms of income are sometimes accepted. Research shows that rather than exclusively targeting the very poor, payday lenders also like to place their businesses in neighborhoods where the median incomes are between $20,000 and $40,000. There are three times as many payday lenders in African American neighborhoods per capita than white neighborhoods.
The usual process is for the customer to pay an exorbitant fee to receive cash in exchange for writing a check to the payday loan maker, which the business holds until that person’s next payday, at which time they cash the check. Interestingly, members of the military were once heavily targeted for payday loans until Congress passed a law banning this form of lending to active duty personnel in 2007, while also capping loans made to service members at 36%.
The Consumers Union (publisher of Consumer Reports) reports that contrary to the claim of payday lenders, people do not just use them once in an emergency, but instead, they frequently get caught in a trap of perpetual indebtedness to the payday lenders–in addition to debts they already carried–repeatedly having to extend the loans they have taken and incurring high fees repeatedly for doing so. The Consumers Union cites one Wall Street analyst who estimates that the average customer of the payday loan industry actually makes 11 transactions per year, snowballing their financial problems significantly. However, when the rent must be paid or else face eviction, or you can’t get to work when your car breaks down, people will opt to engage with these legal loan sharks.
Payday lenders typically claim that their high interest rates are justified because they are making high risk loans where the people they lend to are likely to default. However, according to the Center for Responsible Lending, research shows that default rates are actually similar to that of credit cards which charge (comparatively) much lower interest rates. Payday lenders claimed that they would all leave New Hampshire when the state voted to limit its interest rate at 36%; however, what it interesting is that not all of them left, so apparently they can still make money at that rate.
Payday lenders also like to paint themselves as heroes, people willing to make loans to those in desperate need of money when no one else will lend it to them. If they even remotely resembled heroes, they wouldn’t bilk their customers while raking in billions of dollars at their expense. But more importantly, consumer groups find that getting a payday loan doubles the risk of bankruptcy over a two year period.
People who are hurting for cash do need an alternative, and non-profit payday lenders have come onto the scene. However, they still charge high interest rates; again, because they point to high default rates and administrative costs. That’s where something called micro-lending could play a role. Micro-lending involves the loaning of small amounts of money from poor people to other poor people at low interest rates. It has mostly been associated with developing countries, only recently getting started in the United States. Micro-lending has usually occurred between small business owners, but it would be a worthy experiment to extend the model to consumers of payday loans to see if they could get off the treadmill of debt. Because they operate as borrowing cooperatives, risk from defaulting is spread out among lenders. No matter what method is tried to assist financially precarious people, the practice of preying on lower income people has to be addressed, not just in a handful of states, but in all of them. Meanwhile, we can only hope that Missouri citizens are successful with their ballot initiative.