Why Can't States Fix Payday Lending?
The demise this week of a Louisiana bill that would have reined in payday lending demonstrates how hard it is for states to regulate the quick loan industry, which consumer groups criticize as a trap for the working poor.
Supporters say payday lenders, which emerged in the 1990s, provide a valuable service to lower income borrowers when they need small amounts of money to tide them over from one paycheck to the next. But critics say payday lenders lock desperate people into repeat loan cycles with annual interest rates that can approach 600 percent. An estimated 12 million borrowers use payday loans each year.
State laws governing payday lending vary greatly. Arizona, Arkansas, Georgia, North Carolina and the District of Columbia prohibit payday lending. Eight states—Connecticut, Maryland, Massachusetts, New Jersey, New York, Pennsylvania, Vermont and West Virginia—either do not have specific payday lending statutory provisions or require payday lenders to comply with their general loan interest rate caps, according to the National Conference of State Legislatures. Thirty-eight states, including Louisiana, have laws that specifically allow payday lending. Four of those states, Colorado, Montana, Ohio and New Hampshire, permit the loans but with tight restrictions on interest rates.
Payday loans average $375, have a term of about two weeks, and carry an average fee of about $55 per pay period. The average borrower keeps a loan out for five months and spends $520 on finance charges to repeatedly borrow the same $375, according to a research paper from the Pew Charitable Trusts (which funds Stateline).
Annual interest rates for payday loans range from 129 percent in Colorado, which has some of the tightest payday loan interest restrictions in the country, to 582 percent in Idaho, which has no restrictions, Pew reported last year. Payday industry representatives say those rates are misleading, since the loans are designed to be paid back quickly.
The Pew report found that 69 percent of people who took out the loans used the money to cover a recurring expense, like utilities, while only 16 percent employed the payday loan to deal with an unexpected bill such as a car repair or emergency medical expense.
Pushback in Louisiana
Here’s how payday loans typically work: A borrower takes out a small loan, agreeing to pay what seems like a reasonable interest rate and a minimal fee. To pay back the loan, the borrower writes a check, postdated to his next payday. The lender deposits that check two weeks later, and if there is not enough money in the account to cover the loan and the interest, the lender offers the borrower another loan—for another fee and more interest. The compound interest leads to triple-digit annual interest rates. Moreover, the borrower could be on the hook for a bounced check fee.
Interest rates in Louisiana, at an average annual percentage rate of 435 percent, are among the highest in the country. About 57,000 Louisiana households—23 percent of households in the state—take out a payday loan in a given year, according to the Louisiana Budget Project, which monitors state government spending and how it affects low- to moderate-income families. The group also reported there are more payday lenders in the state (936) than there are McDonald’s restaurants (230).
“Together Louisiana,” an unusual coalition of church leaders and consumer groups, banded together in support of limits on payday lending in the state. The original proposal, authored by Democratic state Sen. Ben Nevers, would have capped the interest rate at 36 percent annually. When it became clear there was not enough support for that idea, Nevers instead proposed limiting customers to no more than 10 loans in a year.
“We don’t see this as the perfect solution but it helps the most egregious payday users not become trapped in a cycle of debt,” said David Gray, policy analyst at the Louisiana Budget Project. “This new bill is more like a field goal whereas the 36 percent would have been a touchdown.”
But even the “field goal” proved too much for state senators, who rejected several different strategies during the debate over the Nevers bill. Opponents argued that all of the limits proposed by Nevers—from an interest cap to an annual loan limit to the creation of a data registry of borrowers—would fatally harm the industry.
Troy McCullen, president of the Louisiana Cash Advance Association, said consumer groups are trying to put him and his fellow small lenders out of business. If that happens, he said, those who need quick infusions of small amounts of cash will use the Internet to tap offshore sources, or else they will be forced to turn to unscrupulous loan sharks.
McCullen said customers want payday loans. “You do have a certain percentage who don’t use our service properly. When someone comes into a store, and they want more and more and more, (their) self-control is not being exercised.”
“As a businessman, I am very prudent in how I handle my customers. If someone has two loans out, I won’t lend to them anymore. If someone goes bad on a $375 loan, I have to make seven loans to make that money back,” said McCullen, who also is president and CEO at Finance America Business Group, a payday lender. “So why would I do that?”
McCullen also argues that it’s not fair to apply an annual percentage rate (APR) to a two-week loan. Under that theory, he said, “if you’re one day late at a Redbox (video store rental), you’ll pay an APR of 18,000 percent.”
But Nevers calls payday lending “nothing more than loan sharking.” He contends that the industry has spent “thousands, if not hundreds of thousands of dollars against this push to regulate this industry.”
Action in Other States
The situation in Louisiana is too new and fluid for organizations to track the influence of industry contributions there, but the National Institute on Money in State Politics found that the Community Financial Services Association, an umbrella payday lending group, has spent more than $20 million in campaign contributions in states over the past decade. Most of that was spent in Ohio in 2008, in an attempt to stop the Ohio legislature from limiting the interest rate on payday loans to 28 percent. The bill was passed anyway, though the industry has since found ways around the interest limit.
The Arizona Financial Services Association spent $14.6 million in that state between 2002 and 2008, but it failed to prevent Arizona from banning payday lending, which it did in 2010 under a statute approved two years earlier.
Other states that considered or acted on payday loans this session include:
- Idaho, where Republican Gov. Butch Otter signed legislation in March that prohibits payday lenders from electronically presenting a borrower’s check more than twice, and limits payday loans to no more than 25 percent of the borrower’s monthly income;
- Maine, where Republican Gov. Paul LePage signed a bill in March that makes an unlicensed loan by a payday lender “an unfair or deceptive act and a violation of the Consumer Credit Code,” subject to fines ;
- Utah, where a scandal involving the payday loan industry two years ago fueled a reform bill signed by Republican Gov. Gary Herbert that will give borrowers time to pay off loans without interest after making 10 weeks’ worth of high-interest payments. The law also requires disclosure of information about the industry in the state, where payday loans carry an average annual interest rate of 474 percent, among the highest in the nation;
- Missouri, where the House and Senate each have passed bills to eliminate renewals on payday loans and lower the allowable interest rate;
- Mississippi, where a bill to limit the interest rate on payday loans to 25 percent died in a Senate committee;
- And Alabama, where the legislature did not approve a bill setting up a database on payday loans and capping the interest rate. The state Banking Department set up the database without a new law, and the loan industry has sued to stop the database from going forward.
Nationally, the federal Consumer Financial Protection Bureau has been collecting information from consumers and others about the payday industry with an eye toward enacting federal regulations, which do not exist now.
The Consumer Federation of America, which has been leading the charge for a federal rule, is calling for regulations that reduce “coercive collection” of the debts, according to Tom Feltner, spokesman for the group. “We need a strong CFPB rule to make sure the borrowers can pay over a period of time. We need some limitations on how lenders can access a bank account, because that substitutes the ability (of the lender) to collect with a real ability (of the borrower) to pay.”