Payday lenders use banks to escape usury
Imagine going to your bank for a loan and being told the annual
percentage rate (APR) would be 400 percent.
If you're thinking that sounds more like one of those
payday loan places than a bank, you're right. But the crackdown
on payday-loan facilities for violating state usury laws has led
some of them to team up with banks in an attempt to get around the
State and national officials are focusing now on the
national banks and, increasingly, federally chartered state banks
that are abetting these schemes.
It's similar to the way credit cards from out-of-state
banks are able to charge higher interest rates than your state allows.
Federal law allows national banks to "export" their interest
rates, along with their product, to other states.
Swimming around state laws
The way it works is payday lenders affiliate with a national bank
and use the bank's charter to get around usury laws and other consumer
protection laws to charge exorbitantly high interest rates on payday
Payday loans are cash advances on a person's next
paycheck -- typically short-term, high-interest loans of no more
than $500. A consumer writes a postdated, personal check for the
amount of money to be borrowed, plus fees, and the check is held
until the next payday -- usually, two weeks.
The borrower then either pays the loan with cash or
the check is deposited, or the loan is rolled over if the customer
can't come up with the money.
Essentially, the payday lender can claim it's the
bank making the loan. However, although the loan's paperwork may
have the bank's name on it, the payday lender is the one advancing
and collecting the money.
Eagle National Bank of Upper Darby, Pa., has been
ordered to stop its payday lending activities. The Office of Comptroller
of the Currency (OCC), which supervises national banks, says payday
lending is Eagle's cash cow, its "most significant lending
product in terms of revenue."
Eagle teamed with payday lender Dollar Financial Group
and let Dollar run the show, according to the OCC.
"Eagle had effectively turned over the management
of the bank's main business to a third party, and then virtually
ignored how that business was being conducted," says John Hawke,
comptroller of the currency.
The OCC says borrowers were charged $15 to $20 for
every $100 borrowed for a two-week period. The loans were carried
on Eagle's books as assets but the bank kept just $4 from each $100
borrowed. Dollar provided the origination, servicing and collection
of the payday loans.
According to OCC figures, Eagle's annual payday-loan
volume increased from $3 million in 1995 to about $400 million by
Eagle didn't return our calls, but Rick Lyke of Financial
Service Centers of America, an organization representing the check-cashing
industry, says these actions may dissuade some banks from partnering
with payday lenders. But, he adds, critics haven't come up with
an alternative solution.
"This is a product that just about everybody
acknowledges there's a need for. Some people have a difficult time
managing short-term cash emergencies. But consumer groups are really
anti-business groups. They've criticized the product for a number
of years but they offer no alternative to consumers who need the
North Carolina attorney general Roy Cooper is suing
payday lender Ace Cash Express, saying its relationship with Goleta
National Bank is simply to get around the law.
Payday loans without the bite
But Cooper agrees with Lyke that there is a need for these services
-- just not under typical payday lender terms.
"I strongly believe consumers should have the
opportunity for small emergency loans on fair terms. I believe there
is a place for these loans, but the problem with the terms of payday
lenders who have hooked up with interstate banks is these loans
are unfair to consumers.
"Ace is charging $17 per $100 borrowed for a
two-week loan. They're claiming this can help a consumer in an emergency,
but a loan like that is like asking for a life boat and being thrown
an anvil. Consumers can quickly get on a debt treadmill."
That debt treadmill begins when the consumer can't
repay the initial loan by the next payday. The borrower rolls over
the loan, plus additional fees -- and gets deeper into debt.
Some states limit how many times a loan can be rolled
over, but payday lenders get around that by having the customer
write a new check to start a new loan.
Jean Ann Fox of the Consumer Federation of America
says payday loans aren't short-term loans, they're long-term debt
burdens that are designed to be unpayable.
"These aren't people who are living paycheck
to paycheck; these are people who aren't making it to the next payday.
They have no savings for the emergencies we all know we'll have
A study by the Wisconsin Department of Financial
Institutions found that the typical payday lender customer in Wisconsin
is female, age 39 and takes home $18,675 annually.
Fox says her organization knows of four, typically
small, national banks and a handful of federally chartered state
banks that are assisting payday lenders.
"Big banks don't want to do this. It's embarrassing
for a bank to be encouraging other bank account holders to write
checks that aren't covered by money. This makes banks uncomfortable,"
Fox says she hopes the FDIC cracks down on state banks to make sure
that rent-a-bank practices don't shift to them because of the legal
actions against national banks.
The best way for consumers to avoid paying sky-high
interest for a short-term loan is to build a savings nest egg. Asking
an employer for an advance on a paycheck could be another alternative.
Fox also agrees that many people who are experiencing
a cash crunch need short-term loans. She'd like to see a more affordable,
less risky scenario with a maximum interest rate of 36 percent and
a $5 administrative fee.
"That recognizes that even with small loans there's
a cost to providing the loan. No loans of more than $300 and a term
of two weeks to pay back every $50 borrowed. That way the payback
is spread over more paydays."
In addition, Fox says there should be a mandatory
break between loans so loans aren't rolled over. She also wants
a single fee of $15 if the check bounces.
"Don't allow lenders to treat the check as if
it's a bad check. The lender knows you don't have the money in the
bank. He shouldn't be allowed to go to court and say, 'This person
committed fraud, it's a bad check,'" says Fox.
Cooper says he's open to negotiation on how loans
could be structured.
"There are a number of good ideas on how
small short-term loans to consumers could be structured on fair
terms. But, clearly, the old payday law and the anarchy we have
now are unacceptable."
-- Posted: Feb. 4, 2002