Bad Credit: How Payday Lenders Evade Regulation
But by the turn of the millennium, Sam’s battered body had reached its limit, and circulation problems in Elsie’s legs had almost forced an amputation. They both went on disability, but even bundling that income with Elsie’s union pension, they found that New York was too expensive a city for their retirement. So they sold their house and bought the two things they needed for their golden years in Charleston: a used Ford Windstar and a small ranch house north of the city.
Small-dollar loan programs are providing a cushion for the poor in Maryland—and spreading around the country.
Unfortunately, that meager wealth made the Blacks lucrative customers for the subprime lenders who have come to dominate their lives. It started with a small loan against the Ford in 2005. They’d gotten behind on the mortgage, which they’d already refinanced, and credit card statements were piling high alongside healthcare bills. So they pulled into one of the title loan shops that saturate South Carolina. “At that time the car was in halfway good shape, so we got $1,400,” says Sam. “Instead of that helping, it put us further back.” They’d have to pay roughly $250 a month for ten months, or $2,500 total.
Within a year, they were in foreclosure. Elsie says she realized it only when a cousin called to say she’d seen a listing for the Blacks’ house in the newspaper. That cousin directed them to a bankruptcy lawyer, who sent them to a credit counseling service and got them a $487-a-month bankruptcy plan. But mortgages are exempt from bankruptcy, and the judgment did nothing to alter the underlying problem: the Blacks’ basic expenses add up to more than their fixed income. They live permanently in the red.
So even though they clawed out of foreclosure, it wasn’t long before they fell behind again on everything else. When a friend showed Sam and Elsie a local Check Into Cash store, they easily slid into the payday lending routine. They borrowed against their disability checks from a ballooning number of lenders every two weeks for the next two to three years, paying out thousands in finance charges for the privilege. They estimate they had at least five loans each at any given time.
The payday lending business model is straightforward. A customer signs over a personal check and in return collects a small loan, usually less than $500 (state laws vary on the maximum allowed). The loan is due when a borrower’s next paycheck comes. As Advance America’s website assures customers, the process takes just ten or fifteen minutes. Lenders charge varying fees for the loans, but when calculated as an annual percentage rate, as mandated by federal law, they are often as high as 400 percent. In South Carolina a $500 loan from Advance America costs $75.40, a 393 percent APR. Lenders prefer the term “fee” to “interest rate,” because the loan is for just two weeks.
But the vast majority of their business comes from loans that flip repeatedly, generating a new fee each time. The average payday borrower takes nine consecutive loans in a year, according to an analysis by the Center for Responsible Lending. In Michigan, state regulators found that 94 percent of payday transactions over a thirteen-month period involved borrowers who had taken five or more loans. In Florida borrowers with five or more loans a year accounted for 89 percent of the market.
“It used to burn me up,” Elsie says, describing the ritual of driving between payday shops to pay off one loan and take out another. “We’d pull up there to pay that money, and we know we gotta borrow it right back.”
The proximity of subprime lenders to one another—and to discount retailers like Wal-Mart—is part of the plan. Drive around Charleston or any urban area in South Carolina and you’ll eventually stumble into a payday valley. A title loan shop sits next door to a rapid tax refunder next to a payday lender and wire transfer station. A garish strip mall near the Blacks’ house is entirely dedicated to half a dozen variations on subprime consumer lending. Just in case customers miss the mall, a billboard in front screams, We’ll Pay Off Your Current Title Loan at a Lower Rate!
As a result of this agglomeration, payday lending saturates black and Latino neighborhoods. A recent National People’s Action report looked at payday lending in five large Midwestern cities. It found that neighborhoods with high concentrations of black and Latino residents had an average of twelve payday lenders inside a three-mile radius, compared with just 4.6 payday lenders for neighborhoods with low concentrations of blacks and Latinos.
As is typical for payday borrowers, at one point in 2008 the Blacks owed four payday shops more than $3,800 in two-week loans—that’s more than 130 percent of their monthly income. At the time, they had twelve simultaneous loans, including four from Advance America.
“Now what company in their right mind would lend that kind of money to someone in that situation?” asks Michaele Pena, the Blacks’ credit counselor. When she met them, Pena estimated their monthly expenses to be about $3,000. Their income, however, is fixed at $2,966. “The Blacks are like the poster child for what we see,” she complains.
Advance America in particular has worked hard to challenge the idea that payday loans take advantage of low-income customers who borrow beyond their means. “Our customers fill important roles in our communities, serving as teachers, bus drivers, nurses and first responders,” wrote now-outgoing CEO Ken Compton in the company’s triumphant 2009 annual report. “The reality is that we all experience financial ups and downs,” explained Compton, who collected a $1.1 million bonus this year, “and we are proud that we have helped so many people get the financial assistance they need.”
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Republican John Hawkins represented Spartanburg, home to Advance America’s headquarters, in the state’s House and Senate for more than a decade before retiring in 2008. He is among the company’s most unforgiving critics. “What these vultures do is nothing but highway robbery,” he says bluntly. In 2007 Hawkins sponsored a bill to ban payday lending in the state, setting off a two-year pitched battle. He still reels from the lobbying blitz Advance America and the CFSA launched against his bill. “It was really taking on one of the most established interests in South Carolina,” he says.
Indeed, CFSA lobbyists have included former State Senator Tommy Moore, a 2006 Democratic gubernatorial candidate, who resigned his seat and became CFSA’s executive vice president in 2007; longtime Democratic operative and 2010 gubernatorial candidate Dwight Drake; and the law firm of former Democratic Governor Robert McNair. Steve Benjamin, Columbia’s first black mayor, once sat on Advance America’s board.
In fighting new regulations, the industry has tried to position itself as a champion of the working class and people of color in particular. It commissioned a study arguing that payday lending benefits both populations, which Representative Harold Mitchell, a black member who also represents Spartanburg, presented to the legislature. “Objective data that payday lenders’ practices ‘lure’ consumers into predatory debt cycles does not exist,” the Mitchell report declared, contradicting sources ranging from the Pentagon to the FDIC. “Isolated cases are often presented in the public media as evidence, but there has been no systematic examination of the extent to which these individual cases are representative.”
One State Senate staffer, speaking on background, talks about getting calls from consumers opposed to regulation who, when questioned, turned out to be in line at a payday shop waiting for a loan. They knew nothing about the legislation when asked.
Hawkins and consumer advocates countered with everything they could, including a class-action lawsuit arguing that Advance America had violated existing “unconscionable lending” laws by making loans it knew borrowers couldn’t repay. As of December 2010 Advance America was fighting or in the process of settling at least eleven suits, according to its SEC reports.
As Advance America brags to investors, industry lobbyists worked with South Carolina legislators to craft a set of reforms that fall shy of capping rates and ending the business entirely. The most stringent of these reforms, which has appeared in states around the country, is a rule declaring that a borrower may have only one payday loan at a time. To enforce the rule, the state created a database of borrowers that lenders must consult before making a new loan. In return, lawmakers raised the state’s ceiling for payday loans from $300 to $550, essentially doubling the amount borrowers may take in one loan.
“We’ve tried to put some speed bumps on it, but it’s an unruly problem,” says State Senator Robert Hayes Jr., a Republican who sits on the Senate Banking and Insurance Committee and who helped shepherd the reform law through. Hayes’s district borders North Carolina and is home to an infamous payday valley, which popped up after the district’s northern neighbor passed a rate cap.
As in other states, the loan-limit rule appears to be slowing the overall volume of loans made. Between February 2010, when the law fully took effect, and January 2011, the number of loans dropped to 1.1 million from about 4 million annually. Given that the ceiling for each loan nearly doubled, that means the loan volume was just about cut in half. It’s still unclear whether the law cut down on repeated flipping or just chased away more casual borrowers. But research from states that have tried loan-limit rules has shown they do not end flipping, and Advance America reports to investors that it doesn’t believe loan-limit rules will affect its profitability in the way that rate caps can.