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DFI > Legal > Payday Lenders > A Report on the Payday Loan Industry A Report on the Payday Loan Industry

The Growth of Legal Loan Sharking: A Report on the Payday Loan Industry

Jean Ann Fox, Director of Consumer Protection

Consumer Federation of America

November 1998

Lending small sums of money at exorbitant interest rates for short periods of time was once considered a social problem requiring the solution of usury and small loan laws. However, payday lenders have persuaded nineteen states to legalize triple digit interest short-term lending and are pressing the remaining states to make payday loans legitimate.

Payday loans have proved very controversial due to the high interest rates charged, collection practices by some lenders, and disputes over compliance with credit laws. These loans sanction the writing of bad checks and entice consumers into relying on very expensive debt to live beyond their means.

In 1997 CFA published a report on check cashing and payday loan practices which found that state consumer protections are inadequate to prevent rate-gouging and to promote informed decisions. This report updates the status of payday lending under state laws and regulations, surveys payday loan terms in 8 states, and offers recommendations to policymakers and advice to consumers.

Payday Loans Provide Quick Easy Credit At a Steep Price

Check cashers, stand-alone companies, and banks are making small sum, short term, very high rate loans that go by a variety of names: "payday loans," "cash advance loans," "check advance loans," "post-dated check loans" or "delayed deposit check loans." Typically, a borrower writes a personal check payable to the lender for the amount he wishes to borrow plus the fee. Fees for payday loans are typically a percentage of the face value of the check or a fee per $100 loaned. Under the federal Truth in Lending Act, the cost of loans must be disclosed as both a finance charge (in this case the fee) and as an annual percentage rate (APR), the standard cost of credit to the borrower on an annual basis.

In a payday loan, both the lender and the borrower know that sufficient funds to cover the check are not available when the check is tendered. The check casher agrees to hold the check until the consumer's next payday, usually up to two weeks. At that point, the consumer can either redeem the check with cash or a money order, permit the check to be deposited, or renew the loan by paying another fee. Payday lenders charge the same fee to roll-over the loan although the transaction costs for a renewal are not comparable.

Although payday lenders typically do not get a credit report on borrowers, they do ask for evidence of an open bank account and current employment. Payday lenders use data base companies, such as TeleTrack, to screen out risky borrowers.

A cash advance loan secured by a personal check is very high priced credit. The National Consumer Law Center reports effective interest rates for payday loans earlier in the decade of 700 to 2000%. The APR varies depending on the fee and how long the check is held before being deposited or redeemed. For a $100 loan for a seven-day period under Iowa's law, the annual percentage rate is 780%; for a five-day period, the annual rate is 1,034%. Loans which are renewed over and over because the borrower cannot afford to pay off the principle while keeping up the fees every 7 to 15 days, carry a steep finance charge. A $100 loan with a $15 fee every two weeks costs 391% APR. This loan, rolled-over three times, costs $60 to borrow $100 for 56 days for the same 391% APR.

Why Payday Lenders Use Personal Checks to Make Small Loans

When payday loans were first offered in the mid-'90s, most state usury or small loan laws made these transactions illegal. By labeling the transaction as check cashing instead of lending, companies sought to avoid credit laws. Litigation by Attorneys General and private class action lawsuits have produced court decisions and settlements confirming that payday loans are subject to usury, limits small loan caps, and other credit protection laws.

Recently enacted laws in some states to permit payday lending define this transaction as "deferred presentment" with the fee not to be considered interest for purposes of state usury laws. Other states have muddled the distinction between check cashing and payday lending by permitting loans to be made if the fee charged is the same as that for cashing a check. Regulators in Florida permit payday loans if the fee charged is the same as that allowed for check cashing (10%) but consider rollovers to be extensions of credit not permitted under Florida's money transmitter law.

Payday lenders benefit from using personal checks as the loan device although the transactions do not require that a check be written. In many cases, the "check" is never cashed, but is returned to the borrower when cash to pay the loan is exchanged for the "check." Loaning money based on personal checks sets up the advantageous comparison in fees between bank bounced check charges and the payday loan fee. A $15 per $100 payday loan fee might look like a bargain compared to a bank's $25 bounced check charge plus a merchant's fee in addition. However, the proper cost comparison for payday loans is with other sources of small loans. A 14 day payday loan with a $15 fee costs 391% APR compared to the typical state small loan interest cap of up to 36% APR. A typical rate for a secured credit card is 24%. Overdraft protection on a checking account costs in range of 18 to 24% plus a small one-time fee.

Use of a personal check makes collection easier for lenders. Consumers can be frightened into paying up to avoid prosecution for bad check charges or civil litigation for triple damages. Use of the criminal process gives payday lenders a collection advantage that no other creditor enjoys. The Florida Comptroller brought charges against a payday lender who used fake sheriff's office letterhead for collection purposes. Attorneys in Ohio report that lenders use the checks without supplying the contract as if they were the victims of bad checks, not a contract in dispute. Holding a borrower's check eases debt collection even when threats are not involved. There is a cost savings to the lender who can "collect" on the debt by sending the check through the bank clearing process. Some payday lenders get borrowers to sign authorization to permit the lender to electronically withdraw funds from the consumer's bank account, using the Automated Clearinghouse system.

Payday Loan Industry

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Payday loans are made by check cashing outlets, pawn shops, and other entities that fill the vacuum left by the majority of mainstream lenders that have left the small loan market. Traditional small loan companies are more likely today to be offering home equity lines of credit than loans for a few hundred dollars for a short period of time. Although some banks, credit unions, and small loan companies make relatively small loans, payday lenders have targeted that market.

Payday lending has exploded in the last few years. Colorado is one of the few states with an industry-wide annual report available. For 1997, the Attorney General reported that 188 lenders made 374,477 post-dated check loans totaling $42,823,089. The average annual percentage rate charged on these loans was 485.26%. The average term for loans was 16.58 days. Over 58,000 of these loans, or 15.5%, were refinanced. For the year ended 12/31/97, Washington reported 562,031 loans made by check cashers. These loans were for a total of $144,923,986. The average size loan was $255. Lenders collected $21,541,338 in fees and charged off $2,054,338. Indiana reports that the number of payday lenders jumped from 11 in 1995 to 59 in 1997, with loan volume increasing from $12,688,599 in 1995 to $98 million in 1997.

Missouri licenses about 450 lenders and reports fast growth. Oklahoma estimates that 900 of 1400 licensed small lenders are in the payday loan business. Idaho, which had two payday lenders in 1993, now has 74. In two years, Iowa payday lenders increased from eight to sixty-four. Louisiana licenses 345 lenders. The number of lenders almost tripled in Wyoming in two years with over $5 million in loans made in 1997, compared to $2.3 million in 1996. Mississippi officials estimated over 350 locations made payday loans in 1998 before regulation. By late March of 1998, Indiana had 96 licensees with 225 branches for a total of 321 locations in Indiana.

Public data on the profitability of

payday lending is sketchy. An Internet posting by Aaffordable Payday Loans claims that company has "$800,000 'on the street' with an average 30% per month return on our money." A cover story in the trade magazine of the check cashing industry noted that "holding a check for a fee is bringing a bundle of profits to increasing numbers of operators."

Check cashing outlets

A seminar at the National Check Cashers Association 1998 convention drew standing room only crowds for check cashers interested in going into payday lending. As check cashers lose a portion of their traditional business to electronic delivery of state benefits and federal payments, check cashers are searching for profitable financial services to replace check cashing. The National Check Cashers Association has issued a position paper in support of payday lending and is working on a model legislative proposal for states that have not authorized payday lending. Loan & Check, a vendor to the trade, claims that payday loans will grow by 600% over the next ten years.

Ace Cash Express, the largest chain of check cashing outlets is based in Irving, Texas, and operates 725 Company-owned stores and 100 franchise stores in 29 states. Its small-loan product offered in 240 stores provides earnings growth. Ace's 1997 payday loan revenue of $10.1 million was double the volume of business in 1996. Act is now opening stores inside Wal-Mart Supercenters. An Oregon news report noted that Ace Cash Express charges $18 to borrow $100 for 14 days, for an effective interest rate of 469%.

Stand Alone Payday Lenders

Stand alone payday loan companies have experienced explosive growth in the last five years. Advance America, Cash Advance Centers, a South Carolina company, have 426 branches in 16 states. The company opened its first store in November 1997 and expects to have over 500 outlets by the end of 1998.

Check Into Cash, Inc. based in Cleveland, TN, opened its first store in 1993 and now operates 340 outlets in 15 states. The company reported revenues of $21.4 million in 1997 and almost exceeded that amount ($21.2 million) for the first half of 1998. For the first six months of 1998, Check Into Cash completed 652,000 transactions attributable to 120,000 customers. Bad debt expense has ranged from 2.3% to 5.6% since 1993.

Other large stand alone payday lenders include National Cash Advance and Check & Go. The company reported a volume of $9.9 million in 1996, nearly triple 1995 revenue. National Cash Advance, another Tennessee company, opened 165 stores in less than three years. Another large stand-alone payday lender, Check 'N Go, started with one store in Cincinnati in 1994 and has about 400 outlets nationwide. Check 'N Go charges $20 for every $100 loaned.

National Banks

Check cashing outlets have formed partnerships with national banks to make payday loans, including in states where check cashers are prohibited from charging typical payday loan rates or extending credit. Eagle National Bank, a federally charted bank located in Upper Darby, Pennsylvania, makes "Cash Till Payday" loans of up to $500 through Dollar Financial Group's check cashers in several states. Dollar Financial Group claims that Eagle National Bank is able to export Pennsylvania's deregulated bank loan fees to consumers in other states. Eagle charges up to $17.50 per $100 for 14 day payday loans (454% APR). In 1997, Eagle National Bank made 204,499 payday loans, with $31 million of the bank's loans small consumer loans (36% of loans made). The Comptroller of the Currency gave a "Satisfactory" Community Reinvestment Act rating to the bank in 1998, despite complaints by consumer organizations about the bank's triple-digit interest rate loans.

The Market for Payday Loans

The market for payday loans is made up of consumers who have personal checking accounts, but who are stretched to the limit financially. These consumers are not even living paycheck to paycheck, but are borrowing against their next paycheck to meet living expenses. Ace Cash Express' Vice President says payday loan customers "tend to be people at the bottom of the middle-class structure in this country." Stephens, Inc. an Arkansas investment company, estimates that the potential market for individuals utilizing store front financial service companies, such as rent to own, check cashing or small loan services, is roughly equivalent to those without an unsecured credit card, or approximately 35 million households.

A Washington regulator says that payday loans are a symptom of whopping credit card debt, as people who are highly leveraged need cash to pay bills. A CFA report on the burden of credit card debt reveals that 55 to 60 million households (55 – 60% of all households) carry credit card balances and that these balances average more than $7,000. A CFA report shows that the typical household with debt repayment problems has a moderate income and credit card debts of more than $10,000.

Lenders claim that their customers prefer to borrow from them than to hock their appliances at a pawnshop or to ask their employers for pay advances. Pawnshop loans are always for a fraction of the present value of the used pawned item, making a pawn transaction a poor comparison. The industry argues that consumers use payday loans to cover emergencies or unexpected medical bills. The West Coast Vice President for Check Into Cash claims that 30% of their customers need money to get their cars repaired. If true that payday loan customers have no savings to cover an emergency prescription or repair job, they are the classic "necessitous" borrower who perceive they have no choices but to borrow at triple-digit rates.

Payday Loans Place Borrowers on a Debt Treadmill

It is not unusual for borrowers to become mired in debt and renew cash advance loans every week or two. Payday loans are structured to make it difficult for consumers to pay in full at the end of the loan period without needing to borrow again before the next payday. A consumer paying off a loan of $100 to $300 plus the $15 to $45 fee within a few days often finds it difficult to make it to the next payday without having to borrow again.

A class action lawsuit filed in Tennessee described borrowers who renewed cash advance loans 20 to 29 times, paying fees of $19 to $24 per $100 loaned. One plaintiff "rolled over" loans 24 times in 15 months, borrowing a total of $400 and paying $1,364 while still owing $248. Bank Rate Monitor Online described a Kentucky consumer who borrowed $150 and had paid over $1,000 in fees over a six-month period without paying down the principal. Her solution was to declare bankruptcy. A Wisconsin news article described a consumer who borrowed more than $1200 from all five payday lenders in her town and was paying $200 every two weeks just to cover the fees without reducing principal.

State Payday Loan Laws

In the last few years, nineteen states and the District of Columbia have adopted legislation or regulations that authorize and regulate payday loans. The District of Columbia, Mississippi, Kentucky, Nevada, and South Carolina legislatures enacted bills in their 1998 session to permit and regulate payday loans.

Alabama's legislature considered a bill but adjourned without adopting pending legislation. Pennsylvania's 1998 legislature adopted a check cashing law that prohibits cashing or advancing money on post-dated checks. A bill to raise the loan amount ceiling in California was withdrawn after consumer advocates objected and proposed amendments to establish reporting requirements for lenders. The Georgia legislature did not adopt bills filed to permit payday lending.

Typical payday loan laws exempt these transactions from usury or interest rate caps, set a maximum fee and term for loans, restrict roll-overs or multiple loans, and require licensing by state regulators. Six state payday loan laws or regulations require lenders to disclose their fees as an Annual Percentage Rate. The maximum fees result in APRs for a $100 14-day loan range from 261% in Florida to 625% in Colorado. Thirteen of the 20 jurisdictions set the maximum fee at $15 per $100 loaned, a 391% APR on a 14 day loan. Sixteen states set a maximum loan term, but only Oklahoma sets a minimum term of 30 days to repay payday loans of $101 or less.

Most states create some type of criminal or administrative penalties. However, only seven states provide for some type of limited private right of action allowing the consumer to obtain relief against the lender. Only a small number prohibit the lender from threatening to file or filing criminal charges against a consumer as a mechanism to collect on the debt. These payday loan laws apply to check cashers in seven of the nineteen states.

Table One

States With Specific Payday Loan Law/Regulations


Category: Payday loans

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