Fact v. Fiction: The Truth about Payday Lending Industry Claims

Published: January 1, 2001

With huge profits at stake, the payday lending industry is fighting reform efforts by positioning itself as "consumer friendly," misrepresenting the facts, and circumventing state laws.

    Claim 1: Payday loans provide needed emergency credit.
    Claim 2: Payday lenders serve the working middle class.
    Claim 3: Customers understand the cost of this service.
    Claim 4: Payday loans are cheaper than other alternatives.
    Claim 5: Fees are high because these loans are risky.
    Claim 6: Most consumers use payday loans responsibly.
    Claim 7: Consumers oppose any limits on payday lending.
    Claim 8: The payday industry is already highly regulated.

  • They say: "Payday loans provide needed credit to consumers for emergency needs"
    In reality: Getting a payday loan usually causes MORE financial problems for a consumer, not fewer.

      While fast cash and no credit checks makes it easy for a consumer to get a payday loan, it usually only postpones the financial crisis for two weeks until the loan comes due. Because payday loans are targeted to people in financial trouble, there are few borrowers who can pay off their loan at that point. 91% of all payday loans are made to borrowers caught in a cycle of repeat borrowing with five or more payday loans per year.

      Borrowers, on average, receive 8 to 13 payday loans per year from a single payday shop. Typically these are loan flips - rollover extensions or back to back transactions loans where the borrower is basically paying a fee for no new money, never paying down the principal owed. The typical borrower’s situation is even worse since borrowers often go to more than one shop (1.7 shops on average), therefore taking out 14 to 22 loans per year. In fact, only one percent (1%) of all payday loans go to one-time emergency borrowers who pay their loan within two weeks and don’t borrow again within a year.

      With such a high payback on their loans, payday lenders are willing to lend to virtually anyone with a checking account and some kind of regular income. This "open door" policy is described by the industry as "serving people who have been denied access to credit by traditional lenders." But payday lenders are actually providing access to debt, not credit. And as bankruptcy and credit card industry statistics confirm, American consumers are awash in more debt than they can handle. For people living paycheck to paycheck, a 400% payday loan is not the answer.

      "I felt like I was in a stranglehold each payday. After awhile I thought, "I'm never going to get off this merry-go-round". During this time, I got a promotion and a raise, but I never saw any of that money. It all went to pay the fees on my loan."
      Anita Monti, NC payday borrower. Anita had to turn to her church for help paying her rent after falling behind with payday fees.

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  • They say: "Payday lenders serve working middle class families."
    In reality: Industry business plans describe targeting customers who are disproportionately minority or low-income.

      The payday industry claim to middle class "roots" is based on a study by the Georgetown Credit Research Center (CRC) that was funded by and produced in collaboration with the payday industry trade group. This study, which not surprisingly attempts to put the best face on the abusive practices of payday lenders, is based on proprietary industry data that cannot be reviewed by independent observers. Read our critique of the Georgetown CRC study.

      The CRC study conclusion that 50% of payday borrowers are middle income is based on interviews with only 427 of 5,400 payday borrowers. Further, researchers down played the fact that almost twice as many borrowers (726) denied they even had a payday loan, and two-thirds of borrowers refused to be interviewed.

      In contrast, actual business plans by payday lenders suggest a different targeted customer base:

      "There are 40 million American households with incomes of $25,000 or less that need convenient check cashing [and] quick availability of micro loans between $50 and $300…Moreover, this market is expected to grow over the next decade; especially those households that are leaving the rolls of welfare for employment."
      Payday business plan

      "Time of year is important…Tax season and Xmas offer [more payday loan] activity; summers can be slower but could be greater if your community grows with migrant workers."
      Payday business plan

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  • They say: "Customers understand the cost of this service"
    In reality: Payday lenders misrepresent the true cost of borrowing to their customers.

      Even the industry-funded CRC study found that over 40% of borrowers believed their payday loan rates were less than 30% APR, not much more than a credit card rate. In fact, payday loan rates are on average thirteen times higher, or roughly 400%. The following excerpt from a payday lending business plan may explain one cause for this confusion:

      "Annual percentage rate [on the customer disclosure form]:…Do not enter a % sign in this box! Simply enter a number. For example…enter the number 805 in box 1. Should you enter 805%, your client may become uncomfortable. Remember, in your response to clients' questions regarding your fees, [say] "We charge $15 per $100 advanced." Sounds like 15%, but in reality since it is an 8 day loan, the true annual percentage rate is 805%!"
      Payday business plan

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  • They say: "Payday loans are cheaper than bounced check charges and other alternatives"
    In reality: The typical payday loan is more than twice as expensive as a credit card late fee, and much more costly than paying bills late. Payday lenders routinely collect bounced checked fees and late fees as well.

      In theory, a payday loan could make economic sense, IF you were in immediate and temporary financial crisis without any other possible source of funds and IF your income was such that you could readily cover a postdated check. In reality, anyone who meets these criteria probably also has access to some form of more affordable credit than a payday loan.

      But for the vast majority of payday borrowers -- the borrowers who take out five or more payday loans per year and account for 91% of all payday loans -- payday lending functions as chronic debt, instead of helpful credit. This is because payday renewal fees are charged repeatedly, while late fees and bounced check charges are one-time fees and do not vary by loan amount.

      Here's a comparison on various late fees compared to the average payday loan made in 2000 in North Carolina ($255 in cash for two weeks):

      $255 payday loan
      $255 bounced check
      Late fee on $255 credit card bill
      Late fee on $800 mortgage (homeowner)
      Late fee on $600 rent payment (renter)
      Late fee on $300 car payment

      * The vast majority of borrowers paid this fee over and over again for no "new money," because they were caught in the debt trap.

      The comparison with small consumer loans is even more telling: a person can borrow $1,000 from a finance company for a year, and pay less than a $300 payday loan over the same period!

      Also, while many states have criminal bad check laws, these do not apply to a check accepted by the creditor with full knowledge that it was not "good" when written. This fact does not stop payday lenders from threatening or often filing criminal cases. Other lenders simply deposit the checks after the consumers fail to repay and then proceed under insufficient-funds laws to collect the principal and interest, the regular bounced check fees, triple the check amount as a penalty, and attorney's fees. For example, the Indiana Department of Financial Institutions found that at least three lenders filed 700 such lawsuits in two years.

      "The threat of a $200 advance eventually costing them in excess of $1,000 and destroying their credit will yield a compliant customer...This [agreement] allows you to collect a multitude of late fees and NSF charges."
      Payday business plan

      "Late fees are a very lucrative profit center. You do not need to actually present a client's check(s) to the bank to have them stamp NSF. Purchase your own stamp! You simply say "My bank verifies funds before accepting my deposit…When I presented your check it wasn't good. The fee is $15 per check." If you broke their payday advance into two or three [smaller] checks, you can let them slide on one[late fee] if you like."
      Payday business plan

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  • They say: "Fees need to be high because these loans are risky."
    In reality: Payday lenders have low losses and high profits (34%+ return on investment).

      A payday lender would have to work hard to lose money, even though borrowers are generally low-income and have weak credit histories. Holding a "live" check as security gives a lender strong collateral and leverage over a borrower who, when faced with the threat of criminal prosecution and penalty fees, will keep paying renewal fees every two weeks when they cannot afford to repay the loan in full and walk away. With these renewals (or loan flips), they are never paying down the principal owed. In North Carolina in 2000, for example, only 6% of payday checks were returned for insufficient funds (NSF) and lenders recovered about 69% of the value on these. They also collected $2 million in NSF fees.

      In comparison, the credit card default rate, like the payday default rate, is also approximately 6% -- but the interest rate on a credit card rarely exceeds 29% (as opposed to payday loans that routinely charge 400% APR or more). Personal loans and car loans have default rates of around 2%, with APRs between 5 and 15%. Compared to other forms of credit, the exorbitantly high APR charged on payday loans is drastically out of proportion with the relatively normal risk involved in making those loans.

      Moreover, if a borrower defaults after repeatedly renewing a payday loan, a lender can actually make money, because accumulating fees quickly surpass the amount lent. In most states, a payday lender loses only 10-12¢ for every dollar loaned out in the few cases when a loan goes unpaid.

      "[Payday lenders] understate profits and overstate default rates to dissuade potential new competitors from entering the industry."
      Payday business plan

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  • They say: "Most consumers use payday loans responsibly"
    In reality: Payday lenders thrive by getting borrowers trapped on a debt treadmill.

      People with legitimate, short-term needs who will pay off their loan within two weeks aren't that attractive to payday lenders. Instead, payday lenders make most of their profits from borrowers who cannot pay off their loans, and instead renew them repeatedly, quickly paying more in fees than they originally borrowed. Borrowers who get five or more loans account for 91% of payday lender revenues.

      Share of Payday Loan Fees Paid by Repeat Borrowers

      This customer "churning" -- not additional consumer demand -- is fueling the growth of the payday industry. For example, while payday revenues in North Carolina grew 27% from 1999 to 2000, the vast majority of this increase came from lenders getting their customers to take out more and larger payday loans.

      "[Lenders] may say they are providing a service to people who just need some money once in awhile until payday. But we were trained to encourage customers the day they paid a loan off to make another loan as early as the next day…We tried to get customers to keep getting loans and borrow up to their maximum approval amount whether they wanted it or not."
      Ex-employee of payday lender in West Virginia

      Source of Payday Lender Revenue Growth, NC 1999-2000

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  • They say: "Consumers appreciate this service and oppose any limits on payday lending"
    In reality: Consumers want (and deserve) non-predatory small consumer loans, not "business as usual."

      According to the industry-funded Georgetown Credit Research Center (CRC) study, 75% of borrowers interviewed believe the government should limit the fees charged by payday advance companies, and 72% believe the government should limit the interest rates that lenders can charge, even if it meant that fewer consumers would be able to get credit.

      Further, the following quotes from a payday business plan provide a glimpse of the real "service" borrowers are getting along with their high-cost payday loans. No wonder 80% of borrowers contacted by the CRC refused to be interviewed or denied they even had a payday loan!

      "These clients are very malleable. They will do as you wish -- they need the money."
      Payday business plan

      "Tell [your clients] if their funds are not good on the day they promised, you must forward their check(s) to your [mythical] "bonding company" so their legal team can pursue the matter."
      Payday business plan

      "Help them visualize a uniformed, gun toting US Marshall arriving at their place of employment. Emphasize to them that this US Marshall will first ask for [their] immediate supervisor!"
      Payday business plan

      "An arbitration clause in all your contracts is good advice; [it] has a chilling effect on class action lawyers."
      Payday business plan

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  • They say: "The payday industry is already highly regulated."
    In reality: State payday laws almost always favor lenders, not consumers. In states with laws with real consumer protections, payday lenders ignore unfavorable state provisions, claiming federal preemption.

      Payday loan legislation passed in 34 states and the District of Columbia does not "regulate" the industry. For the most part, these statutes were drafted by the industry and are intended to permit this type of lending rather than restrict it. These statutes contain few restrictions that actually protect consumers. Another two states have no usury limits and do not otherwise regulate payday loan terms. Only fourteen states, plus Puerto Rico and the Virgin Islands, currently retain their small loan laws and usury limits.

      "The payday advance industry is following the same strategy as the rent-to-own industry and bank/credit card industry. That is, hiring the very best legal minds to enable legislation to allow our industry to grow…The BEST action is a for a state to implement laws enabling our industry!"
      Payday business plan

      In the states with strong consumer protections, payday lenders are using brokering arrangements with banks, known as rent a charter arrangements, to circumvent state bans and usury limits. These lenders claim they are exempt from state law because they have partnered with banks outside the state.

      The Office of the Comptroller of the Currency, the Office of Thrift Supervision, and the Federal Reserve Board have taken significant action to prevent the institutions they regulate from partnering with payday lenders. However, the Federal Deposit Insurance Corporation (FDIC) still tolerates this subterfuge by its member institutions. These small FDIC-regulated banks -– about a dozen -- enable payday loans to be made in fifteen states where such loans are illegal. Several states, such as Georgia and Maryland, have successfully taken action to close the rent a charter loophole.

      Read about the Georgia payday lending law.

      "We have been greatly concerned with [payday lending] arrangements in which national banks essentially rent out their charters to third parties who want to evade state and local consumer protection laws."
      Comptroller of the Currency John Hawke Jr.

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