"Responsible payday lending" sounds like an oxymoron, and in most cases, it is.
After all, the effective interest rates on payday loans are mind-boggling. Let's say you write a payday lender a postdated check for $300 and get $255 in cash, with the lender taking the rest as a fee. If you cover the loan with your next paycheck, your effective annual percentage rate for this transaction is around 450%.
If you have to "roll over" the loan because you can't pay it off with your next check, as often happens, more fees are charged, and your effective annual interest rate soars even more.
Obviously, plenty of people can't do the math, because payday lending has become enormously popular. Consider:
- In the early 1990s, there were perhaps 300 payday lending outlets in the U.S. Today, according to the Community Financial Services Association of America, an industry trade group, there are more than 22,000.
- For comparison purposes, there are only 13,700 McDonald's and 7,300 Burger King restaurants in the U.S., according to those chains' Web sites. So there are more payday lenders than McDonald's and Burger Kings combined.
- Payday lenders make 90% of their revenue from borrowers who roll over their loans at least once, according to the Center for Responsible Lending, and the typical payday borrower eventually pays back $793 for an initial $325 loan.
- Members of the armed forces are three times more likely to use payday lenders as civilians. As many as one in five members of the armed forces took out a payday loan in 2005, a Pentagon report said last year. Military officials say the loans have contributed to rising debt levels that interfere with troop deployment and service members' security clearances.
Payday lenders like to paint their product as a convenient source of emergency cash, but studies of the industry paint a far darker picture. Most payday borrowers roll over their loans at least once, and many extend the loans multiple times and even use multiple lenders, borrowing from one payday lender to repay another. What starts as a quick fix quickly snowballs.
Options for borrowers are limitedAaron Medres, a Washington state truck driver, took out his first payday advance on a friend's recommendation because he didn't have enough money for a needed car repair. Medres wrote a postdated check for $575, got $500 and thought "that would be that."
When payday rolled around again, though, money was still tight, so Medres rolled over the loan. And then the same thing happened the next payday, and the next. Medres began using one payday lender to pay off another and eventually owed money to four companies.
He realized the lenders' fees left him even less money to pay his expenses, but that didn't ease his bind. He and his wife estimate they paid more than $23,000 in fees over four years before they quit using payday lenders.
What changed? Medres lost his job -- and there were no more paychecks to promise to the lenders.
"I told my wife, Terry, 'We've got to do something about this,' " Medres says. She wrote to the lenders "and told them how much we were going to pay."
The lenders eventually agreed to accept the payments -- $25 to each every two weeks -- and the remaining debt was paid off in about a year. Medres says he was luckier than some other borrowers, who report being threatened with jail or fielding harassing calls at work when they can't pay.
Payday lenders say, with some justification, that many of their borrowers have limited access to other short-term borrowing. The payday borrower may not have credit cards or may have maxed them out. Their credit scores are often poor, which makes many mainstream banks unwilling to extend them credit.
Finally, and most damningly, payday lenders point out they're not the only ones charging stiff fees for small loans. Many banks and credit unions have instituted "courtesy overdraft" or "bounce protection," which automatically covers checks that exceed a borrower's balance in exchange for an often-hefty fee.