Consequences of Payday Loans

Gordon Graham here preparing this on July 4 and I trust you had a safe holiday and that all is good for you. I was very pleased to see a lot of talk about our military on the various TV channels today. While you and I enjoy the holiday, there are tens of thousands of our soldiers, sailors, Marines, airmen and Coast Guard people deployed around the world doing the things they do.

Mrs. G and I were shopping at Ralphs yesterday getting all the fixings for dinner tonight, and the butcher was wearing a “Vietnam Veteran” hat. We got to talking and he was with the Navy on a “river boat” in 1968-1969 and I thanked him for his service. He went on to talk about the difference in treatment for returning veterans today and those who returned forty-three years ago. I was finishing up high school in San Francisco then and remember with great sadness the way returning Vietnam veterans were treated.

Obviously I am leading up to something. I recently had the opportunity to have a long, long chat with a very high ranking member of the United States Marine Corps (and that is pronounced “kor” – not “korps” – but I am digressing) and we were talking about the various “risks” that USMC personnel face. As our discussion went from suicide to sniper to IED to vehicle collisions – he brought up an issue I was unaware of.

“One of the greatest risks my Marines face is the “payday loan” operations that are present near every USMC installation.” Again digressing, I was in Little Rock last week and when I was being driven back to the airport, I saw a “bail bonds” establishment. I jokingly said to the cop driving me – “there must be a jail near here” – and he chuckled and pointed out the correctional facility. My dad used to have a similar joke about “animal hospitals” and their proximity to a certain type of restaurant – but I will skip that one today.

Back to the statement from the Marine leader. He was very, very concerned about the “payday loan” operations and the exorbitant interest rates they charge and how they impact his operations and the lives of Marines.

Of course there is a component here of personal accountability and spending more than you make and other issues, but I had no idea on how serious this issue is to the fellow I was speaking with.

With this in mind, I did a quick check online and got some information that you may find interesting – seeing as how this is a “credit union” site and most of you have some “financial” relationship with this credit union. Here is a summary of what I read taken from a “consumer” website.

“Payday” loans are small, short-term loans made by check cashers or similar businesses at extremely high interest rates. Typically, a borrower writes a personal check for $100-$300, plus a fee, payable to the lender. The lender agrees to hold onto the check until the borrower’s next payday, usually one week to one month later, only then will the check be deposited. In return, the borrower gets cash immediately. The fees for payday loans are extremely high: up to $17.50 for every $100 borrowed, up to a maximum of $300. The interest rates for such transactions are staggering: 911% for a one-week loan; 456% for a two-week loan, 212% for a one-month loan.

PROBLEMS CAUSED BY PAYDAY LOANS
1. Payday loans become a trap and are not used on a one-time basis as originally claimed by the industry.
Consumers who must borrow money this way are usually in desperate debt. The high rates make it difficult for many borrowers to repay the loan, thus putting many consumers on a perpetual debt treadmill. Because they cannot repay the loan, they often extend the loan by paying the $17.50 per $100 fee several times over. Thus, many consumers end up paying far more in fees than what they borrowed. This kind of credit puts people in worse financial shape then when they started. For already desperate people, borrowing more money at triple-digit interest rates is like throwing gasoline on a fire.

When this practice was legalized in California three years ago, the industry argued that payday loans were used for occasional emergencies for a short term. This is simply untrue. According to a Wall Street analyst covering the industry, “the average customer makes 11 transactions a year, which shows that once people take [out a payday loan], they put themselves behind for quite some time.

“A manager of PD Chex, a payday lender in Colorado, estimated that only two percent of customers take only one loan. The owner of the store, Avrum Schulzinger, went on to say that “he expects all of PD Chex’s customers to default eventually.” Stories from payday patrons make the results of these subsequent loans clear-consumers take them to meet a quick need, find themselves unable to meet their needs on their next payday, take subsequent loans and quickly get trapped by the outlandish fees.

Payday lenders claim they are the only option for debt-strapped consumers. But borrowing more money at triple-digit interest rates is never the right solution for people in debt. Instead, payday loans make problems worse. As the data shows, virtually everyone takes more than one payday loan and thus the loans are similar to an addiction. This is not a legitimate loan product that benefits consumers. In fact, because most consumers believe they could be prosecuted for passing a bad check, the payday loan suddenly becomes their priority debt. Thus, the original debt problems that brought them to the lender often cannot be resolved.

2. Payday loan rates are way too high, especially given their low risk.
The industry claims its extremely high fees are necessary on account of the risk being taken and its high loss ratio. In fact, in Colorado, one of the few places in the country that collects actual data from the industry, payday lenders charge-off only 3% of the loans made from 1996-1997, while their loans had an average APR of 485.26%. Conversely, California banks charged off 2.7% of credit card debt in those same years, while having an APR of 15 – 22%. Thus, the payday loan industry’s claim of risk and loss simply does not stand up to close scrutiny and do not justify the high rates charged.

Further evidence of the low risk is the rapid growth of the industry, both in California and around the country. Since payday loans were legalized in California effective January 1, 1997, more than 3,500 payday loan outlets have opened in the state. The industry is extremely profitable. A State of Tennessee report stated that the industry return on equity in 1997 was 30%.

3. Payday lenders are virtually unregulated in California.
Unlike consumer finance lenders, such as Household Finance or Avco Finance, who also make small loans, payday lenders are virtually unregulated. Other states have much more regulation for payday lenders including audit, examination, bonding, and reporting requirements.

4. Consumers are easily deceived by payday loans.
This transaction is inherently deceptive. By requiring consumers to turn over a post-dated check, consumers are often coerced or harassed by illegal threats or collection practices. For example, they will be threatened with jail for passing a bad check, even though the law specifically says they cannot be prosecuted if the check bounces. Payday lenders often deposit a check before the agreed-upon date, causing the check to bounce and imposing more fees on consumers.

If you have read my monthly piece regularly over the last few years, you know that my focus in life is trying to educate people about the discipline of risk management. It is more than the safety stuff – there are thousands of risks we face as individuals and organizations. Once you identify a risk, you can build control measures to address the risk.

As I thought about what the Marine executive was telling me, I was trying to build control measures in my head. Here is my nickels worth. We need to educate our children early on in life about “money” – where it comes from and how to be responsible in monetary operations.

I am convinced that if more people understood “money” issues, we would be better off. The young kids who get this knowledge early on in life will be more responsible consumers – and this is good – whether they end up being Marines or a member of Congress. The rule “spend less than you make” is universal in nature.

Gordon Graham
President, Lexipol