Tuesday, May 23, 2006
The loan is typically given in cash
and secured by the borrower's post-dated check that includes the original loan
principal and accrued interest. The maturity date usually coincides with the
borrower's next pay day. On the maturity date the lender processes the check
traditionally or through electronic withdrawal from the borrower's checking
account.
Payday lenders typically operate small stores or franchises, but large
financial service providers also offer variations on the payday advance. Some
mainstream banks
offer a "direct deposit advance" for customers whose paychecks are
deposited electronically. When a consumer requests the direct deposit advance
they receive a predetermined, small cash advance. On the next direct deposit
into the consumer's bank account that advance amount is removed by the bank plus
a fee for the advance (usually around 10-20%). Some income tax preparation firms
partner with lenders to offer "refund anticipation loans" to filers.
In the United States, most states have usury laws which forbid interest rates
in excess of a certain APR. Payday lenders operate in those states by funding
loans through a bank chartered in a different state. Under the legal doctrine of
rate exportation, established by Marquette
Nat. Bank v. First of Omaha Corp. 439
U.S. 299 (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. [1]
Example
For example, a borrower seeking a payday loan may write a post-dated personal
check for $115 to borrow $100 for up to 14 days. The check
casher or 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 $115 in cash, or
refinance ("roll-over") the check by paying a fee to extend the loan
for another two weeks. If the borrower does not refinance the loan, the lender
deposits the check. In this example, the cost of the initial loan is a $15
finance charge, or 391 percent APR.
Many states do not allow rollovers or limit the number of rollovers but, for
example, if the borrower chooses to roll-over the loan three times, the finance
charge would climb to $60 to borrow $100.
Controversy
As a form of subprime
lending, such as high interest
rate credit cards, payday lending is the subject of controversy. Some
critics claim that payday lenders target the young and the poor, near military
bases and in low-income communities, who may not understand the time
value of money. Others go further, comparing payday lenders to loan
sharks due to high interest rates — typically 250% or more when annualized.
There have been reported cases in which payday lenders have pursued criminal bad
check charges, despite the fact that they (presumably) knew the check was bad at
the time when it was written. Likewise, it is argued that the interest rates on
payday lending (and on rent
to own) unfairly disadvantage the poor, compared to the middle
class who pay at most 25% or so on their credit
cards.
Defenders of the higher interest rates note that payday loan processing costs
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.
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.
Payday loan makers also argue that the interest on a payday loan is less than
the costs associated with bounced checks or late credit card payments. For
example, bouncing a $100 check may inccur an NSF fee from the bank of $28 and a
returned check fee of $25 from the merchant.
In comparison, when expressed as APRs for two-week terms:
- $100 pawn
loan with 20% service fee= 240% APR;
- $100 payday advance with $15 fee= 391% APR;
- $100 bounced check with $48 NSF/merchant fees = 1,251% APR;
- $100 credit card balance with $26 late fee = 678% APR;
- $100 utility bill with $50 late/reconnect fees = 1,304% APR.
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. (NCDOJ 2006)
See also
Sources
- FDIC
guidelines on Payday lending
- Community
Financial Services Association of America - Payday lenders' trade
association
- Supreme Court of the United States. Marquette National Bank of Minneapolis
v. First of Omaha Service Corp. et al., 439 U.S. 299 (1978). Accessed on
Findlaw.com. [1]
- North Carolina Department of Justice
(2006). "Payday
lending on the way out in NC." (PDF) URL accessed on 2006-03-22.
External links
- Payday
Lending: Serving the Unbanked - Article by Mike Foley.
- In
Defense of Payday Lending - Article by Tom
Lehman.
- How
the Other Half Banks - Slate.com's
article on the payday loan business.
- Consumer's
Union Fact Sheet
