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Consumers Union, AARP and Consumer Action have sponsored
California legislation to protect consumers by creating reasonable
oversight of the "payday loan" industry. The bill is Senate Bill 834,
introduced by Senator Don Perata (D-Oakland).
"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 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(1) , 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(2) . 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.(3)" 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."(4) 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%.(5) Conversely,
California banks charged off 2.7% of credit card debt in those
same years, while having an APR of 15 -
22%.(6) 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. Therefore, there
is plenty of room for rates to decrease, as called for by SB 834.
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%.(7)
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.
WHAT SB 834 DOES
SB 834 is based on a model bill drafted by national consumer
groups including the Consumer Federation of American and the National
Consumer Law Center. The bill's major provisions are as follows:
1. Reduces the allowable fee for payday loans. The bill essentially allows the same charges for payday loans as the Financial Code currently allows for small loans made by licensed finance lenders. The allowed charges would thus be a $5 "set-up" fee, plus a maximum interest rate of 36% per year (or 3% per month or 1.5% for two weeks). Thus, a $100, two-week loan would cost a maximum of $6.50 ($5 set-up fee plus $1.50 interest) as compared to current law allowing a $17.50 charge. A $200 loan, two-week loan would cost $8, rather than $35.
2. Provides greater disclosure and other consumer protections:
(a) Rollovers: The bill provides stronger protections against "rollover" or extensions of the original loan. For example, a check casher would be prohibited from entering into a second loan with a consumer until 30 days have elapsed from the termination of the first loan. If lenders wish to extend the time for repayment of the loan, they may do so, but cannot charge a new fee for doing so.
(b) Improved disclosures: The bill requires lenders to give a notice to borrowers stating that borrowers cannot be threatened with prosecution for passing a bad check if they cannot repay the loan.
(c) Stronger penalties for violations: The bill allows consumers to recover civil penalties of $2,000 per violation of the law, as well as actual damages, and punitive damages for intentional violations.
3. Provides for greater regulatory oversight by the Department
of Justice, including:
(a) Licensing and bonding: Lenders must obtain a license and maintain a bond to pay claims brought by consumers.
(b) Record-keeping: Lenders must maintain records of each loan to allow examiners to determine if the law was followed.
(c) Reporting: Lenders must file annual reports detailing loan volume, average annual APR of loans and length of loans, along with other information.
ALTERNATIVES TO PAYDAY LOANS
Payday lenders are not the only alternative for consumers facing
debt problems. After all, they were legalized in California two years
ago. Consumers obviously managed to deal with their debt for decades
before anyone had heard of payday loans.
1. Negotiate a payment plan with creditors. The best
alternative to payday loans is for consumers is to deal directly with
their debt. Most creditors will accept partial payments if one sets
up a payment plan. Consumers can negotiate such plans themselves or
contact the local nonprofit Consumer Credit Counseling Services
(CCCS) office for help. Paying off debts through a payment plan,
rather than taking on even more debt at exorbitant interest rates, is
the best way to deal with financial problems. CCCS offices also teach
money management skills to help consumers prevent financial problems
in the first place.
2. Credit cards/Secured credit cards. Some credit card
companies specialize in consumers with financial problems or poor
credit histories. Consumers should shop around and not assume they do
not qualify for a credit card. Secured credit cards are another
option. A secured card is basically a credit card tied to a savings
account ($500 for example). The card's credit line is the amount
deposited in the savings account. The funds of the account "secure"
the amounts charged on the card. Once a consumer has successfully
used the secured card for 6 months - 1 year, they can then qualify
for a regular unsecured credit card.
3. Advances from employers. Many employers will grant
paycheck advances to employees. Because this is a true advance, and
not a loan, it obviously is a better alternative than payday
lenders.
4. Credit unions. Credit unions offer small, short-term
loans to their members. Many more consumers can join credit unions
now that affiliation requirements are less strict.
5. Overdraft protection. Most banks offer checking
accounts with overdraft protection. Payday lenders claim their fees
are lower than paying bounced check fees, but a better alternative is
to prevent bounced check fees in the first place.
6. Lines of credit from finance lenders. Finance lenders
such as Household offer small lines of credit to consumers with less
than perfect credit histories. These credit lines range from
$2,000-$5,000 with interest rates from 25-35% APR.
________
Footnotes:
(1) Current law allows lenders to charge 15% of
the "face amount of the check." Civ. Code Sec. 1789.33 (emphasis
added). Because the face amount of the check must also include the
fee for the loan, in order to borrow a net amount of $100, the
consumer must write a check for $117.62 ($117.625 x .15 = $100). Most
lenders simply round off the $17.62 amount to $17.50.
(2) Analysis, Assembly Committee on Banking and
Finance, SB 1959 (Calderon), p. 5 ("Arguments in Support") (June 24,
1996).
(3) M. Anderson, "Cash poor, choice rich,
Paycheck-advance firms move in," Sacramento Business Journal (Jan.
11, 1999).
(4) A. Berenson, "Fringe banking hot despite
bite, Payday loans' interest rates legal," The Denver Post (May 5,
1996).
(5) State of Colorado Department of Law, Office
of the Attorney General, "Post-Dated Check Cashers Supervised
Lenders' Annual Report." (1996 and 1997)
(6) California Bankers Association.
(7) State of Tennessee, Dept. of Financial
Institutions, Report to the General Assembly on the Deferred
Presentment Service Act at 9 (1998).
Consumers Union's
West Coast Regional Office
November, 1999
