Thursday, July 03, 2008

Center for Responsible Lending responds to critics of predatory series

Leslie Parrish, a senior researcher from the Center for Responsible Lending, responds to the previous post outlining complaints from a pro-indsustry group, Borrow Smart Alabama.

Payday lenders can no longer market their worst products to military families because the Department of Defense went to Congress and asked for the 36% interest rate cap, testifying that payday lending was the worst financial problem for their troops in a hundred years and that it was affecting our nation's readiness for war.
In 2006, the Military Lending Act (MLA) limiting interest rates on small loans to 36% annual interest for active duty military members and their families was passed by Congress and signed into law by President Bush. This law took effect October 1, 2007.
The MLA was introduced out of concern by the Department of Defense that servicemembers were being targeted by payday lenders and other financial predators lining bases. The Defense Department was especially worried about servicemembers losing their security clearances because of the high level of indebtedness to these lenders, and its effects on troop deployments in Iraq and Afghanistan.
The Wall Street Journal published an article on high-cost lenders preying on elderly populations earlier this year. As a result of this and other concerns, the Social Security Administration recently held a comment period to address the extent to which Social Security benefits were being taken to repay these loans. In addition, the House Ways and Means Committee held a hearing yesterday on this subject.
The industry says that payday loans are not "conducive" to people on fixed incomes, but that doesn’t stop them from marketing them. The debt trap is particularly hard for those on a fixed income to escape, because they can't work another job or extra hours to pay off their payday debt.
In North Carolina, a 69-year-old man had been in an Advance America loan for five years - it was a loan of about $300 flipped repeatedly first on every payday for his job as a warehouse worker and then once a month when he received his Social Security benefits. He paid over $5,000 in fees for this loan and was referred to the Center for Responsible Lending by his bankruptcy attorney.
We compiled demographic information reported by the industry and state regulators on payday borrowers and found that payday borrowers are more likely to be:
- below median income, with a significant portion of borrowers earning less than $25,000
-African-American or Latino

Further, payday lenders advertise themselves as helping folks who have nowhere else to turn and a lack of other options. They defend their high fees by noting that their borrowers cannot get conventional credit.

You say (via CRL): Short term lenders are "allowed to charge the equivalent of 456 percent interest."
Under the Truth in Lending Act, the Federal Reserve requires an annual percentage rate (APR) to be disclosed on loans of any term—whether for one day or 100 years. The goal of this law is to allow consumers to more readily compare loans of differing terms to determine which best suits their needs. For example, using APR, a consumer can see the price differences between a two week payday loan, six month installment loan, or an open-ended credit card cash advance on an "apples to apples basis." Under federal law, payday loans must carry an APR disclosure.
As Borrow Smart Alabama notes, payday loans can be for terms of 10 to 31 days in this state, with the term generally depending whether the borrower is paid once or twice a month. Nationally, the average payday loan is for two weeks. APRs for a 10, 14, and 31 day loan term are calculated below. CRL’s calculation of APR is consistent with how this measure is described in federal law and in payday lending applications.
APR on a loan with a $17.50 fee per $100 borrowed, by loan term

10 day term (min. loan term) 639%
14 day term (typical loan term) 456%
31 day term (max. loan term) 206%

Unfortunately, because overdraft fees are not considered an extension of credit, and therefore not covered under the Truth in Lending Act, banks do not have to disclose an APR for this service. We are in favor of having an APR disclosure apply to this product as well, as we believe that this is also an extension of credit.

Background on CRL and Self-Help Credit UnionThe Center for Responsible Lending is a nonprofit, nonpartisan research and policy organization dedicated to protecting homeownership and family wealth by working to eliminate abusive financial practices. CRL is affiliated with Self-Help, one of the nation's largest community development financial institutions.
Since 1980, Self-Help has helped over 60,000 borrowers buy homes, build small businesses, and strengthen communities in North Carolina and around the country. Self-Help was recognized as one of twelve high-impact U.S. nonprofits in the book Forces for Good, along with other organizations such as Habitat for Humanity, The Heritage Foundation, Teach for America, National Council of La Raza and YouthBuild USA.
Self-Help has never offered payday loans and does not benefit from CRL’s advocacy work in this area. Contrary to payday lending industry charges, Self-Help cannot profit from the shutdown of payday lending in states such as Georgia, Arkansas, New Hampshire, Oregon, West Virginia, Pennsylvania, Ohio, etc…not only does Self-Help not offer payday loans, it does not make consumer loans in any of these states. In addition, Self-Help does not engage in high-cost overdraft loan programs of which the payday loan industry and CRL are critical.
The Center for Responsible Lending’s research is well-respected. The Federal Reserve Board notes that "CRL has produced ground-breaking research on the subprime mortgage market and has been a key advocate for state and federal protections that reasonably balance consumer interests with the goal of increasing sustainable homeownership with affordable loans."

A typical borrower pays back $793 in fees and interest to a payday lending, all
for the privilege of receiving $325 in cash

The payday industry has misled the public and policymakers about the nature of their product since it was conceived. The two-week loan is a myth, payday loans are closed and re-opened repeatedly even in states where immediate renewals are illegal.

Looking at state regulator data (including that supplied by Veritec Inc, which contracts with select states to collect data), we found that: (1) the average payday borrower took out nine loans every year; (2) the average loan size was $325 and (3) the average fee for this size of loan was $52.

While most states ban a direct renewal of payday loans, in which a borrower pays a fee to extend the loan out another two weeks, lenders routinely circumvent this law by what are called "back-to-back" transactions. With this type of transaction, the borrower pays back the loan and its fee and then—often before they even leave the store—they re-borrow the same amount from the lender. While this is not technically a renewal, it serves the same purpose for both the borrower and the lender.

Looking at data from Veritec, we found that most payday lending operates in this manner. A borrower pays back the loan, then takes out another within the same pay period, and often at their first opportunity, as evidenced in reports from Oklahoma and Florida. Back-to-back transactions are not providing borrowers with new credit; instead, they are a clever way to rollover a loan without falling under the legal definition of a renewal.

If an initial $325 loan with a $52 fee is taken and then renewed 8 times (a total of nine loans), then the borrower would pay back $793 ($325 in principal and $468 in fees).

Other research on the benefits/costs to payday lending
Donald Morgan, a staffer at the New York Federal Reserve, has drafted two working papers dealing with payday lending over the past few years. Neither has been published, nor are their findings endorsed by the Federal Reserve. The report finding North Carolina and Georgia residents bounced more checks, filed complaints with the FTC more often, and filed for bankruptcy more after payday lenders left has significant methodological problems. For example, the authors note that bankruptcy rates increased in Georgia after payday lenders left relative to the national average. However, other factors such as unemployment, divorce, or health care coverage which differ between states. The returned check data used to report increases for Georgia and North Carolina after payday lending was banned includes not only these two states, but also returned checks from Alabama, Louisiana, South Carolina, southern Mississippi, and Tennessee—states where payday lending is legal. The authors did not separate out Georgia and North Carolina-specific data from these others states which allow payday lending.

Overall, because payday borrowers make up a small portion of the overall population, it is somewhat dubious to expect large shifts in statewide data such as bankruptcy or bounced check rates if one particular credit option is removed.

Other research that looks at the experiences of actual payday borrowers yields far different results. Two economists—Paige Skiba of Vanderbilt and Jeremy Tobacman of Oxford—were granted access to several years of payday borrower data from one of the nation’s largest lenders. They found that taking out payday loans increased the chances of bankruptcy among borrowers, as compared to similarly-situated households who did not take a payday loan. In addition, the North Carolina Banking Commissioner asked UNC to do a study of the effects of the payday lending ban in that state. Researchers at UNC found that residents—including former payday borrowers—were glad that these loans were no longer available.
"[T]his problem with predatory lending, with payday lending, is the most serious single financial problem that we have encountered in [one] hundred years." Admiral Charles Abbot, Pres., Navy-Marine Corps Relief Society at the Senate Banking Committee hearing on Pentagon’s report on predatory lending, Sept. 14, 2006