Despite what the talking heads are saying, the economy isn’t doing so well. In this most recent jobs report, the two main sectors of growth were fast food and retail, accounting for a total of about 32.2% of jobs created in October. And due in part to these low-paying jobs, many more people are using payday loans to get by. Why does it matter?
Unfortunately, when it comes time to pay up, many people are paying much more than what they borrowed due to extremely high interest rates. While the issue gets raised in the mainstream media every now and then, rarely has anyone taken a look how payday loans came into existence – and the type of real financial havoc they wreak on people, mainly the poor. We need to realize that payday loans only harm us, and to explore alternatives.
According to a 2007 article in the Journal of Economic Perspectives, the practice of getting credit against one’s next payment goes back to the Great Depression. However, “the spread of direct deposit and electronic funds transfer technologies slowed the growth in the demand for check cashing services,” and payday loans played more of a side role to check-cashing businesses. But in 1798 the situation changed, facilitating the rise of payday lenders.
The Origins of the PayDay Loan
The beginnings of payday loans can be found in the 1978 Supreme Court case Marquette National Bank v. First of Omaha Service Corp, which stated that “national banks were entitled to charge interest rates based on the laws of states where they were physically located, rather than the laws of states where their borrowers lived.” The ruling allowed banks to offer credit cards to anyone they deemed qualified.
A further empowerment came from the Depository Institutions Deregulation and Monetary Control Act of 1980, which allowed banks and financial institutions to decide interest rates based on the market. This laid the foundation for payday loans, since one could now set up a payday loan company and charge high interest rates claiming they were based on the market. Payday lenders could offer loans to literally anyone they wanted, even those with bad credit.
As most of us now know, payday lenders are able to profit off the loans they provide by charging interest – often exorbitant interest, which gets out of control. For example, “for a loan of $300, a typical borrower pays on average $775, with $475 going to pay interest and fees over an average borrowing cycle.” In 1999, the Federal Reserve Bank of Cleveland noted that loans had “annualized interest rates often ranging from 213 percent to 913 percent.” In other words, the interest on a payday loan could vary between 4.4% and 19% – per week.
Today, the situation has only slightly improved as interest on a two-week loan can be between 391% and 521% annually, or 8.14% to 10.85% weekly. When one factors in that “only 14 percent of borrowers can afford enough out of their monthly budgets to repay an average payday loan,” we can see the beginning of a debt cycle where interest quickly and dangerously adds up.
Who's Getting Hurt?
While it’s known that mainly working-class people and the poor are the primary users of payday loans, that population is spread out over a rather broad spectrum. More specificity, Pew Research in 2012 reported that the majority of payday loan borrowers are 25- to 44-year-old white women, though “there are five groups that have higher odds of having used a payday loan: those without a four-year college degree; home renters; African Americans; those earning below $40,000 annually; and those who are separated or divorced.”
Furthermore, the Journal of Economic Perspectives found that many payday loan borrowers “are seriously debt burdened and have been denied credit or not given as much credit as they applied for in the last five years.” In other words, the victims of payday loans come from groups and communities that are already having economic troubles – even more so due to the current economic climate. As to why and when people take out the loans, the Journal found that “most borrowers use payday loans to cover ordinary living expenses over the course of months, not unexpected emergencies over the course of weeks." More than anything, perhaps, this speaks to the problem of wages: that people aren’t being paid enough.
Worse still, not only is the bottom line for payday lenders “significantly enhanced by the successful conversion of more and more occasional users into chronic borrowers," reported the Economic Development Quarterly, "[but] the federal government has found that one of the country’s biggest payday lenders provides financial incentives to its staff to encourage chronic borrowing by individual patrons.” In short, companies are either purposefully seeking – or have a strong financial incentive – to put vulnerable populations into a cycle of poverty that is extremely difficult to get out of.
There has been some attempt by state governments to regulate payday loans. Some states have banned them outright, whereas others have limited interest rates. The lenders, though, are getting smart and attempting to avoid regulation by “making surface changes to their businesses that don’t alter their core products: high-cost, small-dollar loans for people who aren’t able to pay them back.”
Who Are the Culprits?
It should be noted that payday lenders are no small chumps in the financial world. Not only did their industry have [a revenue of $9.3 billion(http://www.bloomberg.com/news/2013-04-24/payday-loan-curbs-considered-by...) in 2012, but for a while even major banks were involved in payday lending including Wells Fargo, Bank of America, US Bank, JP Morgan Chase and National City (PNC Financial Services Group). These mega-banks were able to finance 38% of the entire payday lending industry, and even that is considered a conservative estimate.
In January of this year, the big banks bowed out of the industry after being warned by federal regulators who were looking to see if the loans violated consumer protection laws. But despite these Wall Street players leaving the industry, the problem doesn’t end there. There are also middlemen involved, which operate on behalf of the payday companies.
In April, Responsible Lending reported that a lawsuit was being filed against Money Mutual which “[claimed] the company [was] operating as an unlicensed lender by arranging loans that violate a [Illinois] state law that restricts borrower fees.” Money Mutual is itself not a lender, but “a lead generator that sells sensitive customer information, like bank-account numbers and email addresses, to payday lenders, and federal and state officials increasingly are cracking down on these businesses.” Middlemen like Money Mutual can be paid $50 to $150 per "lead," even if a person doesn’t take out a loan.
And the numbers can quickly add up. In 2012, Bloomberg News found that “lead generators in financial services take in $100 million a year, with the market growing by more than 16 percent annually.” Yet this is just with storefront lenders, and many new problems arise when one delves even deeper into the world of online payday lending.
Many online payday lenders “attempt to skirt the rules and charge exorbitant fees, amongst other affronts to regulations that leave many a consumer seeking payday loan legal help.” The Pew Research Center also “found that about 30 percent of Internet payday loan borrowers claim they have received at least one threat from the lender,” whether in the form of arrest or that the debtor’s employer would be contacted.
One of the worst problems with online payday lenders is theft. Take the story of Jeannie Morris of Kansas City. She entered personal information on websites that offered to match her up with payday lenders. The situation took a turn for the worse when, “without asking her approval, two unrelated online lenders based in Kansas City had plopped $300 each into her bank account. Together, they began withdrawing $360 a month in interest payments,” and after her account was wiped clean, Jeannie was hounded by collection companies.
But Jeannie is not alone, as “many consumers reported that loans they’d never authorized had been dropped into their bank accounts. Then those accounts often evaporated as the lenders snatched out money for interest payments while never applying any of the money to the loan principal.” In short, online payday lenders can lend people money without asking them – then clean out those people’s bank accounts, effectively stealing from families.
Some Alternative Solutions
The situation may seem hopeless, but there are alternatives to payday loans. One way to avoid them is through credit union loans, whereby members are allowed to borrow up to $500 each month and each loan is “connected to a SALO cash account, which automatically deducts 5 percent of the loan and places it in a savings account to create a ‘rainy day fund’ for the borrower.”
Small consumer loans are another option. They are a lot less expensive than payday loans; for example, “a person can borrow $1,000 from a finance company for a year and pay less than a $200-$300 payday loan over the same period." Some people can also get a cash advance on their credit card. In the long term, credit counseling can help people create debt repayment plans and find a way to balance their budget.
Most agree that payday lenders are a major problem: they prey on the desperate in order to make money. For this reason, people need to organize and fight for their economic freedom. Consumer watchdog groups, payday borrowers and victims of payday theft need to come together to end the practice that creates a never-ending cycle of debt. To quote the rallying cry of IWW songwriter Joe Hill: “Don’t mourn, organize!”