Bad Credit: How Payday Lenders Evade Regulation
These reforms came too late to prevent the Blacks from falling into a payday loan morass. But Michaele Pena’s savvy, patient counseling did help them get out. Pena doesn’t even bother negotiating with subprime consumer lenders; it never works. Instead, she makes a budget for her clients, figures out a reasonable repayment plan and starts sending payments until the original debts are cleared. That’s how she got the Blacks out of their payday debt trap.
Small-dollar loan programs are providing a cushion for the poor in Maryland—and spreading around the country.
With the cycle of fees broken, the Blacks were able to catch up on the actual loan principals, one loan at a time. In two and a half years, they paid off nearly $5,000 in debt, including the bankruptcy settlement. They negotiated away another $2,000, and as of September 2010 they were finally debt free.
Or, they would have been. The nearby garish strip mall has a more subdued but equally treacherous neighbor, anchored by a personal finance company called Regional Finance. Offering loans on slightly longer terms secured by household items rather than paychecks, personal finance companies are not subject to South Carolina’s new payday loan rules. In fact, the payday reforms appear to have spurred their growth. Advance America consolidated the state’s payday loan market in the wake of the new regulations, and industry watchdogs suspect that rivals, like Check ‘n Go, have relicensed themselves as personal finance companies.
Like its competitors, Regional sends mailers to area households with checks for pre-approved loans. In July 2010 Elsie accepted one for $446; she’ll pay $143 in finance charges over the life of the loan. Sam took one out too, in December 2009, to buy Christmas presents. Elsie can’t recall why she took hers, but when pressed both of them mumble about being too generous and fret that everything just seems more expensive these days. Both were shocked when told that they got the same deal from Regional that they did from the payday lenders they despise.
“They have gone through this cycle over and over again,” says a frustrated Pena. “I’ve tried to educate them, and they’re the sweetest people, but they just don’t get it. I don’t know what to do other than to be there to intercept their mail.”
In some ways, the finance companies are an improvement. The loans flip less often because they tend to be for three to eighteen months, not two weeks. But the idea remains the same: a loan for less than $1,000 with fees that translate into extremely high interest rates that can be flipped when it comes due. For Hawkins, these loans prove a simple point about subprime consumer lenders of all stripes. “There’s only one way to get rid of them,” he says. “And that’s to pull it out root and branch.”
Indeed, states that have tried to regulate high-cost consumer lending have found it a full-time job. In state after state, payday lenders who faced new rules simply tweaked their businesses without changing the core model. Since 2005, for instance, Advance America and others have recast themselves as credit repair organizations in states that maintained interest rate caps on nonbank lending. Notably, this began after the FDIC barred payday lenders from partnering with out-of-state banks to evade rate caps. They charge a borrower a standard payday lending fee, then connect the borrower with a third-party lender who finances the small-dollar loan at a legal rate. According to Weed, this is legal in twenty-six states.
Variations on this theme are myriad. When Ohio capped interest rates in 2008, Advance America began offering cash advances under a mortgage lender license. When Virginia tightened payday lending rules in 2009, the company started offering loans as open-ended lines of credit, until the state regulator stepped in. In New Mexico, after the state passed a seemingly strict set of regulations, lenders created longer-term installment loans similar to those of South Carolina’s finance companies and, according to a study by University of New Mexico legal scholar Nathalie Martin, transferred customers directly into the new regulation-free loans without informing them. Others offered payday loans without taking a check as security, a modification that put them outside regulatory bounds.
Lenders have also simply ignored the law. After North Carolina passed its 36 percent interest rate cap in 2003, a consumer group filed a class-action lawsuit, based on an investigation by the attorney general’s office, charging that Advance America went right on lending at triple-digit rates. In September 2010 Advance America settled the suit for $18.75 million, the largest payday settlement in history.
Advance America also assures its Wall Street investors that it’s keeping up with the changing regulatory climate by exploring new products. It began offering prepaid debit cards, and by 2009 it had more than 167,000 cards loaded with $374 million. In 2007 it partnered with MoneyGram to offer wire transfers in its stores. In late 2008 it launched a web-based payday application that logged 95,000 new loans in its first year.
Consumer advocates say all this suggests one solution: a federal cap on nonbank consumer lending like the one that went into effect for service members in 2007. President Obama promised to do so during his 2008 campaign, and Senator Dick Durbin introduced bills in 2008 and 2009 that would have created a 36 percent cap, a return to earlier usury laws. Advance America is blunt about how that would affect its business. “A federal law that imposes a national cap on our fees and interest would likely eliminate our ability to continue our current operations,” declares its 2010 annual report.
The Congressional rate cap discussion was displaced, however, by the heated debate over the 2010 financial reform law, which dealt with the question by creating a new consumer-protection watchdog. Congress granted the new Consumer Financial Protection Bureau (CFPB) oversight of the previously unregulated nonbank lenders, including payday lenders. But that was largely directed at the mortgage brokers that had pushed subprime home refinances, and the bureau is primarily embroiled in a debate over how much authority it will have over Wall Street banks. With every financial industry player lobbying hard to limit the bureau’s authority, CFPB will be able to police only so many products, and early reports suggest it will concentrate on mortgages. When it comes to payday lenders, the bureau is expected to focus on consumer education and enforcing disclosure rules. In state efforts, neither has proven an effective counterweight to the industry’s saturation of working-class neighborhoods with predatory products.
Disclosing payday lenders’ APR has done little to help borrowers like the Blacks because, says Pena, the math of their financial lives doesn’t add up. “When people are desperate to pay someone else, and these people are calling me and harassing me and they want $300 today and, whoops, look what I got in the mail today…” She throws up her hands at what happens next.
For the Blacks, Pena has a sinking feeling about what’s next. Neither of them is healthy, and Sam worries what will happen if one of them ends up in a nursing home, or worse. He’s asked Pena to look into a reverse mortgage for their house, which would ensure they can stay in it until they both die. Pena’s not optimistic that it will work out, given how little equity they have. They are one health crisis away from homelessness.
“I’m winding down my career,” Pena says. “And I thought when I got into this industry twenty-something years ago that things would be better by now. But they are in fact worse, because of the different products that have come out.” It used to just be credit cards, which was something she understood. Now, she says, she barely recognizes the personal finance world. “I don’t know—the financial world just got greedy and went cuckoo.”
Also in this issue, Adam Doster reports on a new alternative to payday loans that is being tried in Baltimore.