Why do you think that people get stuck in mortgages they can't afford and payday loans that multiply their debt? I'll give you a clue. They don't wake up one morning and say, "I think I'll get myself into financial trouble." They're often lured into these loans by salespeople who know better but whose living depends on pretending not to know.
You've read plenty about wiggy mortgages and the brokers and lenders who tout them. So I'll move to the payday loans used by more than 19 million families last year. They borrowed nearly $48 billion from lenders in storefronts and online. The attraction: quick loans in small amounts, with no traditional credit check. The trap: high costs and a good chance of spiraling into monstrous debt.
Payday lenders serve people with steady jobs and bank accounts who need a small loan to get through the month. To borrow, you write a personal check for the sum you want. The loan lasts until your next paycheck arrives—usually up to 14 days. At that point you repay in cash or let the lender cash the check. Online lenders collect by accessing your bank account directly. Typical fee: $15 per $100 borrowed ($30 if you borrow online) for annual interest rates ranging from 300 to more than 500 percent. On a $300 loan that's more than it costs to bounce a check.
If you borrow once or twice, a payday loan solves a problem fast. But if it leaves you short again next month, you'll probably borrow the money back and pay another fee. Over two years, a $300 loan, renewed and renewed, can cost $2,340 or more and you're still in debt.
The debt spiral isn't entirely your fault. These loans are designed to be easy to get into but hard to get out of, say three former employees of Check 'n Go, the nation's second largest payday chain. William Harrod, Micheal Donovan and Cameron Blakely held a press conference last month in connection with a successful city-council vote to ban payday loans in Washington, D.C. To raise his bonus, Blakely said, he had to increase his "customer count." One way of doing that was to keep current customers in hock by encouraging them to borrow more than they wanted. That made it harder for them to repay. Check 'n Go has a plan that lets borrowers pay over 90 days at no extra charge. But Donovan, a store manager, said, "We instruct our staff not to tell customers that the option exists." In a phone interview, Harrod spoke of a customer who had paid $8,000 on a repeating $375 loan. "That made the picture clear to me," he said. He quit.
Check 'n Go president David Davis disputes what his ex-employees said. Only a quarter of his customers take more than four loans in a row, he says. Loans are limited to less than their take-home pay. Bonuses emphasize getting new customers rather than repeaters, and the sales staff isn't told to keep quiet about the 90-day repayment plan. Check 'n Go has sued Donovan for concealing a criminal record (forgery and larceny) when he took the job. It also alleges that he passed company secrets to the Center for Responsible Lending, an organization that opposes payday loans. Donovan says he "shared the truth" with the public. A CRL spokesperson "reaffirmed our commitment to fighting abusive payday lending." (I'm not picking on Check 'n Go. The whole industry needs scrutiny.)
The huge appeal of payday loans raises the question of alternatives. An obvious one: borrow that $300 from relatives, if the expense is critical, or spend $300 less. In the 12 states that ban payday loans, you can borrow small amounts from traditional consumer finance companies. Ward Scull, who owns a moving company in Newport News, Va., thinks small and midsize companies should offer cash-advance programs to rescue employees trapped by multiple loans. Scull got involved in this issue after one of his workers fell into inescapable debt. He's leading a group that's trying to end payday lending in Virginia.
The most promising solution so far is an effort by credit unions to create low-cost payday products for their members. QuickCash, at Langley Federal Credit Union in Hampton, Va., offers 36-day loans for $100 and up at an annualized rate of 18 percent. Summit Credit Union in Madison, Wis., chose a 29.9 percent line of credit with a $25 annual fee. Both programs just about break even but show how much cheaper payday lending can be. The USA Federal Credit Union in San Diego, for the military and others, loses money on its 18 percent program but sees it as a member service.
The industry's big success story comes from the State Employees' Credit Union in North Carolina. Its payday loan, at 12 percent, is "our most profitable product," says CEO Jim Blaine. Repayments are made automatically from checking accounts.
Starting this week, a new federal law caps the interest rate on payday loans to military families at 36 percent. The goal: to save soldiers from lending abuse. Working families deserve that protection, too. It's proving too easy to tie them up in debt.