Payday loans can wreak havoc on a person's financial life. These loans carry sky-high APRs and the penalties for late or missed payments can be extreme. Many consumers, who turned to payday lenders in a time of need, later find themselves worse off than when they started. In this series, WalletPop takes a look at the payday lending industry and some of its players: those who dole out the loans, the regulators who try to rein them in and the people who desperately take out these loans hoping for a some relief. This is the third installment of our payday lending series. You can read the first part of this series here.
Before payday lenders came onto the scene, pawn shops and mom-and-pop check-cashing services made a tidy little profit off of those who were desperately seeking access to cash. Noticing the high profits and the minimal amount of regulation surrounding these loans, larger, deep-pocketed companies began getting in on the act, gaining a significant amount of momentum in the 1990s. Making matters worse, these lenders were successful in convincing state legislatures to exempt their businesses from usury laws, which set a limit on interest rates. That meant lenders could charge rates that climbed well into the triple-digit percentages.
Despite raking in profits hand over fist, the payday lending industry has hit a significant hurdle in recent years. State governments have begun to strike back. West Virginia ran payday lending out of the state years ago. Pennsylvania essentially killed payday lending with regulations back in 2006 and 2008; New York virtually finished them off in the state in 2003 and 2004 when then-Attorney General Eliot Spitzer kept suing payday lenders into oblivion. North Carolina got rid of payday lending in 2001, and payday lenders largely left Georgia after the government set a maximum APR limit of 60% on loans in 2004. Other states where payday lenders have been almost entirely forced out of town include Connecticut, Maryland, Massachusetts, New Jersey, Vermont and the District of Columbia.
Just last year, Arkansas managed to eradicate payday lending as well. H.C. "Hank" Klein is the founder of Arkansans Against Abusive Payday Lending in Little Rock and he helped spearhead a campaign to get rid of payday lending in the state. Klein grew to dislike the payday lending industry when he was the chief executive of a credit union.
"A lot of the checks that were bounced were payday loan checks," says Klein. "And I just saw too much of that."
The worst case that he can recall was a customer who worked for the Department of Justice and made about $90,000 a year. Nonetheless, this guy "had a lot of toys," says Klein, like boats and fancy cars, and when the man's son lost his job, he took out a $300 loan at a payday lending store and then gave the money to his son.
That should have been a clue right there: You can "afford" a boat and make $90,000 a year, but you don't have $300 in cash on hand to give your adult son? Klein says that the borrower couldn't pay back the $300 within two weeks, and everything snowballed until he was taking out loans from payday centers to pay back other payday lending centers.
"Three years later, this guy owed 12 payday lenders," says Klein. "Every other Monday, he would take off work and spend the day renewing these loans. It was costing him $3,000 a month."
"Payday loan products are defective from the word go, designed to keep people in debt and financial slavery," says Klein. "They're counting on you not being able to pay back the loan in time, and that you'll have to keep renewing the loan, or paying it back and then taking out another one, over and over and over again."
So it was to Klein's great relief that, in the summer of 2009, the last payday lending store in Arkansas closed after a lengthy fight in the courts. Just three years earlier, there were 275 payday lending stores throughout the state, more than twice the number of McDonald's restaurants.
There are plenty of states left where payday lending is legal. In Ohio, where I live, the state tried to limit what payday lenders could charge on interest, with the Senate passing an annual 28% payday lending rate-cap law in 2008, but lenders quickly found a loophole in the law. Instead of lending cash, lenders now issue loans in the form of a money order, and then charge the borrower to cash it.
Although -- and I hate that I know this from personal experience -- you can decline to pay the fee to have the money order cashed (at least that was the case at the payday lending chain I went to). You can instead take the money order to your bank, which will then treat it as though it were a check, cutting the payday lending costs approximately in half.
Ohio is slowly cracking down on payday lenders, as is Maine, New Hampshire, Oregon and very recently, Montana. During the last election, Montana voters voted to cap the interest rate on payday loans at 36% APR. In the past, that's been a percentage low enough to drive payday lenders out of the state, which may well happen with Montana.
However, there are other states like South Dakota, Utah, Wisconsin and Delaware, where payday lenders operate virtually unchecked with no interest cap on the loans they issue.
While many states are actively targeting payday lenders, the federal government has been somewhat slow to respond. In 2007, after years of seeing servicemen and women fall victim to payday lenders, Congress to made it illegal for payday lenders to give loans carrying an APR of more than 36% APR. Because those costs are severely below what the payday industry normally receives for a loan, many payday lenders simply now refuse to lend money to U.S. military members.
It is suspected that once the nation's new Consumer Financial Protection Bureau is in full swing, payday lenders and other predatory forms of financial assistance may be in big, big trouble.
But for now, for those who live in states that have payday lending, you're on your own.
Geoff Williams is a frequent contributor to WalletPop. He is also the co-author of the book Living Well with Bad Credit.
Other stories in this series:
Payday loans: How one woman got caught in a vicious cycle
Payday loans: Why the industry says they are a good deal
Payday loans: State governments try to run payday lenders out of town