A bill to reduce Alabama’s 456%-high interest rate failed this week, further proof that Washington needs to step in now
The latest evidence that we need Washington to step in and provide comprehensive reform of the payday loan industry came this weekend courtesy of the state of Alabama, where legislation that would have capped such loans at a 36% interest rate died in the final hours of the state legislative session.
Even a “compromise” bit of legislation that would have resulted in the interest rates getting chopped to a mere 391%, could not get out of legislative committee.
The rate now? Try 456%.
And to think that once upon a time we banned loan sharking.
The payday loan industry profits by preying on the increasing economic vulnerability of Americans. Our semi-stagnant economy, where household income has dropped by a median 8% since 2000, and decent middle-income jobs are being replaced by low paying part-time minimum wage positions, has left increasing numbers of people economically desperate. A recent paper by the National Bureau of Economic Research found that one in four of us had turned to high interest borrowing to get by, bringing increasing business to everyone from payday loan and auto-title lenders to pawnshops and rent-to-own outfits.
When it comes to payday loans, the initial terms can seem, if not enticing, at least reasonable. Terms are frequently two weeks, with the result that the payday loan industry presents the expenses for the consumer for just that time frame. A $10 fee for a $100 loan doesn’t sound bad, does it? But because of the economic vulnerability of those seeking payday loans, many can’t pay up when the note comes due 14 days later. They roll the debt over again and again. According to the Pew Charitable Trusts the average borrower pays $520 in interest annually.
This is why the phrase “cycle of poverty” exists.
Not many of us take on this sort of debt willingly. Pew says a third of the people they studied had no other options when it came to getting their hands on the needed funds. Think about it for a minute. No one earning six figures, possessing a decent credit score, and enjoying access to decent financial services thinks, “I could use my 15% APR credit card to pay that unexpected doctor bill that I acquired after my younger son was slammed in the face by a loose gate in Riverside Park at recess (true example from my life, folks!). But no, I think I’d rather pay more than double the face amount for a short-term $500 loan.”
As Chris Hainey, a banker and volunteer teacher with Operation Hope, the financial literacy organization that works with low-income communities told me, “When your only financial choices are keeping money on your person, using a high-fee currency exchange for check cashing and bill payment and borrowing from instant-credit stores, it is easy to make bad decisions that keep you trapped in poverty.”
The Alabama bill ultimately faltered not only over attempts to cap the annual interest rates, but by bill sponsors’ attempts to limit the number of times a consumer could borrow payday loan money annually, and set up a statewide mechanism to enforce the law. But supporters were no match for the payday loan industry, one which has more than 1,000 places of business in the state employing 5,000 people to give out 5m loans to 300,000 customers every year. According to the Montgomery Advertiser, they brought on seven lobbying firms to help defeat the legislation, not to mention such industry trade groups as one with the delightfully oxymoronic name of Borrow Smart Alabama.
The problem of regulating this stuff on a state-by-state basis is that it is like playing a game of whack-a-mole. If Washington state puts tight controls on such loans, California might go in the other direction. There is also the increasing number of online Internet payday loan operators, where loan fees are even higher, to offset the expenses of customer acquisition and higher rate of default.
This is an area where there is some light, some good news. The Consumer Financial Protection Bureau recently released its own study of the issue, and is widely thought to be moving toward proposing federal rules governing the payday loan biz.
Moreover, late last month, the Federal Deposit Insurance Corporation and Office of the Controller of the Currency released proposed rules to curb the burgeoning number of banks offering something called deposit advance loans. These bank issued short-term high-interest loans could accurately be described as payday loans for customers who don’t wish to visit a storefront outfit located in a less than desirable part of town, and would rather handle the transaction in a more respectable setting. Among the regulations being proposed: forcing the banks to treat the loan like any other bank loan – like, say, a mortgage – and make a judgment about the borrowers ability to pay. Among the banks in this less than traditional banker line of business: Wells Fargo, U.S. Bancorp and Fifth Third Bank.
It’s worth noting that Fifth Third also “sponsors” the teaching of payday loan hater Dave Ramsey’s financial literacy program in high schools within its business footprint. If you are wondering, the main textbook, Foundations in Personal Finance, describes such payday loans as “a horrible greedy rip-off.” Ramsey himself has referred to the industry on his popular radio program as filled with “scum-sucking bottom-feeding predatory people who have no moral restraint.”