In January 2001, Pam Sanson found herself with a $300 bill that she could not pay. Desperate for some quick cash, she went to a payday lender and wrote a check for $375 to cover the $300 loan plus a $75 finance charge. Sanson left with the understanding that the lender would not deposit her check until she came back in two weeks to pay off its face value or paid $75 to extend the loan.
At the time, Sanson was confident that she would be able to pay off the loan the following payday. Her husband soon lost his job, however, and Sanson had to cut her work schedule at Wal-Mart because of surgery. These unexpected hardships left Sanson unable to pay off the interest which amounted to a 600% annual percentage rate or the principal on her loan. Sanson’s check bounced and USA PayDay threatened to send detectives to put her in jail. In just six months, Sanson accrued $900 in interest alone without having reduced the amount on her principal.
The payday loan industry has profited from desperate borrowers like Pam Sanson to become one of the fastest-growing sectors of the “fringe banking” industry. Payday loans, also known as “deferred presentments,” “cash advances,” or “check loans,” are small, short-term loans where the consumer provides a postdated check for the amount borrowed plus a finance charge.
The lender holds the check as collateral until the next payday, a period ranging from one to four weeks, with the most common lending period being two weeks. At the end of that time, the borrower can pay off the loan by paying its face value in cash or by allowing the lender to deposit the check. If the borrower cannot pay the loan or does not have enough money in her account to cover the check, then she pays another fee to extend or “rollover” the loan for another period.
According to a 2001 survey, the annual percentage rate (APR) on fees charged by payday lenders ranged from 390% to 7300%, averaging close to 500%. Despite these exorbitant interest rates, payday loans have become increasingly popular among consumers who may not qualify for credit cards or loans through mainstream banks. Consumer advocates have lobbied for more stringent state and federal regulations that impose interest rate caps, limit the number of rollovers allowed per customer, and force lenders to disclose the terms of their loans.
Industry representatives, however, argue that payday loans are a valid consumer product, filling a market for small, short-term loans that banks have abandoned. Payday lenders justify the high interest rates on their product as the fair cost of disbursing high-risk, unsecured loans. Like other consumer products, payday loans should be left to market forces of supply and demand, rather than imposing artificial interest rate caps or restrictions. The industry also argues that regulation will actually have the effect of excluding from the credit market high-risk borrowers the very people that consumer advocates are trying to protect. The paternalistic nature of regulations prevents consumers from exercising their choice to purchase a valid consumer product.
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PDF Payday Loans: The Case For Federal Legislation by Pearl Chin
