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A payday loan or '''paycheck advance''' is a small, short-term Loan that is intended to cover a borrower's urgent expenses until their next payday. Typical loans are between $100 and $1500, are usually on a 2 week term, and usually have interest rates in the range of 390 percent to 900 percent ( Annualized ). They 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 . Though payday lending is primarily regulated at the state level, the United States Congress passed a law in October 2006 that will cap lending to military personnel at 36% APR. The Defense Department called the lending "predatory," and military officers cited concerns that payday lending exacerbated soldiers' financial challenges, jeopardized security clearances, and even interfered with deployment schedules to Iraq. USA Today: Law caps interest on 'payday advances' to servicemembers Some federal banking regulators and legislators seek to restrict or prohibit the loans not just for military personnel, but for all borrowers, because the high costs are viewed as an unnecessary financial drain on the lower and lower-middle class populations who are the primary borrowers. Lenders point out that these loans are often the only option available to consumers with bad credit who have urgent expenses and cannot get a bank loan, credit card, or other lower-interest alternative. Critics counter that most borrowers find themselves in a worse position when the loan is due than they were when they took the loan, with many getting trapped in a cycle of debt. The industry's fast paced growth indicates a highly profitable business model. Statistics show that the majority of the industry's profit comes from repeat borrowers, who are unable to pay them off on the due date and instead repeatedly renew their loans, paying fees each time. Financial Quicksand: Payday lending sinks borrowers in debt with $4.2 billion in predatory fees every year THE LOAN PROCESS Borrowers visit a payday lending store and secure a small cash loan, usually in the range of $100 to $500 with payment in full due at the borrower's next paycheck (usually a two week term). Finance charges on payday loans are typically in the range of $15 to $30 per $100 borrowed for the two-week period, which translates to rates ranging from 390 percent to 780 percent when expressed as an annual percentage rate ( APR ). The borrower writes a post-dated 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. Payday lenders require the borrower to bring one or more recent pay stubs to prove that they have a steady source of income. They are also required to provide recent bank statements. Each individual company has their own underwriting criteria. Most payday borrowers pay back the loan when due. 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 typically operate small stores or franchises, but large financial service providers also offer variations on the payday advance. See below: "Variations on Payday Lending". Example 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 the payment plan. If the borrower does not refinance the loan, the lender may deposit the check. In this example, the cost of the initial loan is a $60 finance charge, or 390% percent APR . SUMMARY OF THE LENDING MARKET
CONTROVERSY AND CRITICISM Payday lending is a controversial practice and faces both legal battles and public perception challenges in nearly every state. Exploiting Financial Hardship For Profit Critics blame payday lenders for exploiting people's financial hardship for profit. Lenders target the young and the poor, particularly those near military bases and in low-income communities. 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 point out that payday lending unfairly disadvantages the poor, compared to the Middle Class who pay at most 25% or so on their Credit Card s. However, supports argue that some individuals that require the use of payday loans have already exhausted or ruined any other alternatives. They may not be able to obtain a credit card, or rely on secondary sources (such as loans from friends and family members). Aggressive Collection Practices By law, a payday lender can use only industry standard collection practices, the same as would be used to collect any other debt. 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 Fast Cash Loans Charged by State Regulator . This practice is illegal in many jurisdictions, and has resulted in regulatory action. Payday lenders have been known to call a debtor's neighbors, or talk with their coworkers regarding overdue loans. Pricing Structure of Payday Loans Defenders of the higher interest rates note that processing costs for payday loans do not differ much from their higher-principal, longer-term counterparts such as home mortgages. They argue that conventional interest rates at these 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. An August 2007 New York Times article, "Nonprofit Payday Loans? Yes, to Mixed Reviews," {Link without Title} details a payday loan alternative being offered by the Goodwill, a non-profit, tax-exempt charity. Goodwill charges customers $9.90 per $100 borrowed for their “Good Money” payday loan. This equates to 252% APR. The goal is to break even. For-profit payday lenders charge an average of $15 per $100 borrowed while also paying taxes, employee salaries and health care, rent and overhead costs. Critics counter that 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 making a determination about the borrower's ability to pay back the loan. Net Profitability A study by the FDIC Center for Financial Research found that “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". U.S. House of Representatives Committee on Financial Services Democratic Office ALTERNATIVES TO PAYDAY LOANS Many believe that payday loans are the only option for consumers with bad credit, but other options do exist and most financial counselors would direct people to explore the alternatives.[http://www.toledoblade.com/apps/pbcs.dll/article?Date=20050509&Category=NEWS08&ArtNo=505090302&SectionCat=&Template=printart The Toledo Blade: Local payday lenders cash in on rising short-term needs] Other options are available to most payday loan customers. Times Dispatch: Other Options Exist These include:
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):
Neutral consumer information The Canadian federal government publishes a booklet called The Cost of Payday Loans {Link without Title} which compares the costs of borrowing the same amount of money using various credit products, including a payday loan. The booklet also explains how payday loans work and the many fees and charges that can apply. It is published by the Financial Consumer Agency Of Canada . REGULATION AND LEGISLATION 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. The U.S. Congress recently approved a provision capping loans to military personnel at 36% APR. The Defense Department report said the average {Link without Title} borrower pays $827 on a $339 loan and called the lending "predatory". Military officers pushed for the law, saying the loans saddled low-paid enlisted men and women with debts that ruined their finances, jeopardized security clearances and left them unable to deploy to Iraq or other assignments. The provision was signed into law by President Bush on 2006-10-17 , and will take effect on 2007-10-01 . Payday lending is legal and regulated in 37 states. In Georgia and 12 other states, it is either illegal or not feasible, given laws on the books. Atlanta Journal-Constitution: Payday lenders hope to return in Georgia, 3/18/07 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, most states have (1978), the loan is governed by the laws of the state the bank is chartered in. 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. Text of ''Marquette Nat. Bank v. First of Omaha Corp.'' decision from Findlaw 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 6 payday loan renewals. FDIC's Revised Examination Guidance on Payday Lending 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. Some states have laws limiting the number of loans a borrower can take at a single time. Some states also cap the number of loans per borrower per year, 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. Borrowers often circumvent these laws by taking loans from more than one lender. Regional Legislation 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. 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. 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. Regulation in New Mexico New Mexico will cap fees, restrict total loans by a consumer and prohibit immediate loan rollovers, in which a consumer takes out a new loan to pay off a previous loan, under a new law that will take effect on 11/1/2007. A borrower who is unable to repay a loan will automatically be 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 will allow the term of a loan to run from 14 to 35 days, with the fees capped at $15.50 for each $100 borrowed. There also will be a 50-cent administrative fee to cover costs of lenders verifying whether a borrower qualifies for the loan, such as determining whether the consumer is still paying off a previous loan. A borrower's cumulative payday loans could not exceed 25 percent of the individual's gross monthly income. Forbes.com: NM Governor Signs Payday Lenders Bill Payday loans in Canada According to the Canadian Criminal Code , any rate of interest charged above 60% per annum is considered criminal. On August 14 2006 , the Supreme Court Of British Columbia issued its decision in a class action lawsuit against A OK Payday Loans. A OK charged its customers 21% interest, as well as a "processing" fee of C$ 9.50 for every $50.00 borrowed. 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.A OK Payday Loans Inc. v. Watt, 2006 BCSC 1213 (2006). The British Columbia Court Of Appeal unanimously affirmed this decision. A OK Payday Loans Inc. v. Watt, 2007 BCCA 231 (2007). Federal legislation passed in the spring of 2007 transferred regulatory authority on payday loans to the provinces. PROPONENTS' STANCE Although some view payday loans as predatory or even loan sharking that target low-income clients, proponents are adamant that payday loans provide a service that is not available from many national banks. Many banks do not offer small, short-term loans and these payday loans fill a niche in the economy. Many cities across the United States are implementing ordinances on the manner in which payday loan centers conduct business. Economic studies show that consumer credit, even at very high rates of interest, is generally welfare-enhancing. A staff report released by the Federal Reserve Bank of New York concluded that a payday loan should not be categorized as "predatory" since they may improve household welfare.[http://www.newyorkfed.org/research/staff_reports/sr273.html "Defining and Detecting Predatory Lending", Federal Reserve Bank of New York Staff Reports, Number 273, January 2007] The working paper, "Defining and Detecting Predatory Lending," reports that "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." Results of the report indicated that payday loans may actually do the opposite by improving the welfare of the consumer. VARIATIONS ON PAYDAY LENDING Direct Deposit Advance Some mainstream Bank s offer advances for customers whose paychecks or other funds are deposited electronically into their accounts. A customer requesting a "direct deposit advance" receives a predetermined cash advance amount that is deducted, along with a fee (usually around 10%-20% of the amount borrowed), when the next direct deposit is posted to the customer's account. Refund Anticipation Loans Income tax preparation firms including H&R Block partner with lenders to offer "refund anticipation loans" to filers; such 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. 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 Numbers 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. The Consumer Federation of America conducted a survey of 100 Internet payday loan sites showed that 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. the Consumer Federation of America: Consumers Warned of Online Payday Loan Sites NEUTRAL GOVERNMENT INFORMATION The Canadian federal government publishes a booklet called The Cost of Payday Loans,http://www.fcac-acfc.gc.ca/eng/publications/PayDayLoans/CostOfPaydayLoans_TOC_e.asp which explains how payday loans work and the various fees and charges that can apply. The publication also illustrates the cost of borrowing using a payday loan, compared to the cost of borrowing the same amount using other credit products. The booklet is published by the Financial Consumer Agency Of Canada . SEE ALSO REFERENCES
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