Claudie Harris, 54, of Kansas City, Mo., knows about living on the edge. She owes about$5,000 toward her late husband's medical bills. She's paying it, slowly, from the salary she earns as a housekeeper at a facility for the mentally ill. But that leaves her a little short. So, to get by, she's been taking payday loans, which are loans against her future earnings. "It's easy money," Harris says.
People with shaky credit can borrow more easily than ever before—against houses, of course, but also against their paychecks and even their cars—whether or not they're in a position to repay. There are now some 24,200 payday-loan storefronts, up from 18,000 three years ago, according to Stephens Inc., a Little Rock investment bank—and more than 300 new payday outlets on the Internet. First American Loan Performance reports that subprime mortgages accounted for 16 percent of the market last year, up from 9 percent in 2000. Leverage like this puts consumers at much greater risk of delinquency and default.
With a payday loan, you write a postdated check against your next pay period and walk away with cash. The fees are stiff—Harris usually pays $50 for a $250 loan. In two weeks, the loan falls due. If you can't pay, it costs another fee to renew the debt for another two weeks. Pretty soon, the amount of interest could exceed the original loan, making it difficult to dig out: Harris's receipts show an annual interest rate of 521 percent.
For someone with a phone bill due, no cash or credit but a paycheck on the way, a single payday loan can work. Mary Jackson, of the payday trade group the Community Financial Services Association, calls them "a valuable public and consumer service." But to Jean Ann Fox, of the Consumer Federation of America (CFA), they're a "debt trap." Borrowers tend to take serial loans, at high expense, and struggle to repay. "It's like being an addict," Harris says (she's promised herself to end her debt and dependence by June 1).
Car-title loans can get consumers into even more trouble, says Randall McCathren, president of the auto-finance consultant BLC Associates. Like payday loans, they're marketed as a way to get quick cash in an emergency. You can borrow anywhere from $250 to $2,500 against a paid-up vehicle, giving the lender your title and a duplicate car key as security. There's a fee upfront and a triple-digit interest rate, the loan falls due in 30 days, and each time you renew you're charged the fee, plus interest, all over again. If you can't pay, you lose the car or truck you may need to get to work.
Thomas Elliott, 36, and Joshua Reel, 26, of Broadway, Va., are fighting to save a car. Last September, they took a $250 loan from Loan Max in Harrisonburg, Va., against a 1988 Pontiac. Both handicapped, they live on Social Security disability and can't read well enough to understand the loan documents, says their Legal Aid lawyer, Grant Penrod. They thought that a payment of at least $61 a month would retire the loan in four or five months. No dice. They paid $278, then went for help when they saw that the amount they still owed had actually risen to $309.86. Loan Max's attorney, William Pratt, says the loan was fully explained, but Loan Max is willing to give Reel and Elliott all their money back. Penrod thinks the men should go for damages, and no settlement has been reached.
Payday and car-title lenders tend to cluster in low-income neighborhoods—especially around military bases, where families are young and borrowers aren't very savvy about interest rates. Congress recently slapped a 36 percent interest-rate cap on loans made to members of the armed services. But it left out everyone else, who pay rates that sometimes exceed 700 percent, says CFA's Fox.
Of all the predatory loans, "exploding mortgages," with interest rates that wing up after two or three years, are probably the most toxic and have made the most headlines. They're typically granted to borrowers classed as "subprime"— those with credit scores under 620 (a 900 score is tops). But these are the very people least able to handle monthly payments that suddenly double or triple. The Center for Responsible Lending says that one in five of the subprime loans made in 2005 and 2006 will likely fail.
So far, the Feds have pretty much let the lending predators range unchecked. But there's something new today—"the high level of pain and suffering," says John Taylor, head of the activist National Community Reinvestment Coalition. "If this isn't enough to move Congress to act, what will it take?"