Payday loan

From Wikipedia, the free encyclopedia

A payday loan or paycheck advance is a small, short-term loan (typically up to $1,500 in the U.S.) that is intended to bridge the borrower's cash flow gap between paydays. Payday loans are also sometimes referred to as cash advances, though that term can also refer to cash provided against a prearranged line of credit such as a credit card.

Contents 1 Process 2 Example 3 Controversy 4 Proponents' Stance 5 Withdrawal from North Carolina 6 Payday loans in Canada 7 Neutral Government Information 8 See also 9 References 10 Sources 11 External links

[edit] Process

The loan is typically given in cash and secured by the borrower's post-dated check that includes the original loan principal and accrued interest. The maturity date usually coincides with the borrower's next payday. On the maturity date the lender processes the check traditionally or through electronic withdrawal from the borrower's checking account if the borrower does not first repay or service the loan in person. Some payday lenders require the borrower to bring pay stubs for a prescribed period leading up to the current week in order to insure that the borrower has a steady source of income and is likely to be able to cover the check if cashed.

Payday lenders typically operate small stores or franchises, but large financial service providers also offer variations on the payday advance. Some mainstream banks offer a "direct deposit advance" for customers whose paychecks are deposited electronically. When a consumer requests the direct deposit advance they receive a predetermined, small cash advance. On the next direct deposit into the consumer's bank account that advance amount is removed by the bank plus a fee for the advance (usually around 10-20%). Income tax preparation firms including H&R Block partner with lenders to offer "refund anticipation loans" to filers; such loans are not technically payday loans (because they are repayable upon receipt of the borrower's income tax refund, not at his next payday), but they have similar credit and cost characteristics.

In the United States, most states have usury laws which forbid interest rates in excess of a certain APR. Payday lenders formerly operated in those states by forming relationships with banks chartered in a different state with no usury ceiling (such as South Dakota or Delaware). Under the legal doctrine of rate exportation, established by Marquette Nat. Bank v. First of Omaha Corp. 439 U.S. 299 (1978), the loan is governed by the laws of the state the bank is chartered in. This is the same doctrine that allows credit card issuers based in South Dakota and Delaware — states that abolished their usury laws — to offer credit cards nationwide.^[1] Recent actions by federal banking regulators have forced commercial banks to discontinue payday lending, with the effect that nearly all lawful payday loans in the United States are made by state-licensed lenders.

[edit] Example

For example, a borrower seeking a payday loan may write a post-dated personal check for $115 to borrow $100 for up to 14 days. The check casher or payday lender agrees to hold the check until the borrower's next payday. At that time, the borrower has the option to redeem the check by paying $115 in cash, or refinance ("roll-over") the check by paying a fee to extend the loan for another two weeks. If the borrower does not refinance the loan, the lender deposits the check. In this example, the cost of the initial loan is a $15 finance charge, or 124 percent APR. Many states do not allow rollovers or limit the number of rollovers but, for example, if the borrower chooses to roll-over the loan three times, the finance charge would climb to $60 to borrow $100.

[edit] Controversy

As a form of sub-prime lending, similar to high interest rate credit cards, payday lending is the subject of controversy. Some critics claim that payday lenders target the young and the poor, particularly those near military bases and in low-income communities, who may not understand the time value of money. Others go further, comparing payday lenders to loan sharks due to high interest rates — typically 300% or more when annualized. Payday lenders have been known to charge more than 1000% APR. There have been reported cases in which payday lenders have pursued criminal bad check charges, despite the fact that they (presumably) knew the check was bad at the time when it was written.^{[citation needed]} Likewise, it is argued that the interest rates on payday lending and on hire purchase contracts unfairly disadvantage the poor, compared to the middle class who pay at most 25% or so on their credit cards.

Defenders of the higher interest rates note that payday loan processing costs do not differ much from their higher-principal, longer-term counterparts such as home mortgages. They argue that conventional interest rates at these lower dollar amounts and shorter terms would not be profitable. For example, a $100 one-week loan, at a 20% APR (compounded weekly) would generate only 38 cents of interest, which would fail to match loan processing costs.

A study by the FDIC Center for Financial Research found that “operating costs lie in the range of advance fees” [collected] and that, after subtracting fixed operating costs and “unusually high rate of default losses,” payday loans “may not necessarily yield extraordinary profits.” Based on the annual reports of publicly traded payday loan companies, loan losses can average 15% or more of loan revenue. Underwriters of payday loans must also deal with people presenting fraudulent checks as security or making stop payments.

Payday loan makers also argue that the interest on a payday loan is less than the costs associated with bounced checks or late credit card payments. For example, bouncing a $100 check may inccur an NSF fee from the bank of $28 and a returned check fee of $25 from the merchant.

In comparison, when expressed as APRs for two-week terms:

• $100 pawn loan with 20% service fee= 240% APR;
• $100 payday advance with $15 fee= 391% APR;
• $100 bounced check with $48 NSF/merchant fees = 1,251% APR;
• $100 credit card balance with $26 late fee = 678% APR;
• $100 utility bill with $50 late/reconnect fees = 1,304% APR.

[edit] Proponents' Stance

Although, some view payday loans as predatory or even loan sharking that target low-income clients, proponents are adamant that payday loans provide a service that is not available from many national banks. Many banks do not offer small, short-term loans and these payday loans fill a niche in the economy. Many cities across the United States are implementing ordinances on the manner in which payday loan centers conduct business. Economic studies show that consumer credit, even at very high rates of interest, is generally welfare-enhancing.

A staff report released by the Federal Reserve Bank of New York concluded that payday loan should not be categorized as "predatory" since they may improve household welfare. The report, "Defining and Detecting Predatory Lending," reads that "if payday lenders raise household welfare by relaxing credit constraints, anti-predatory legislation may lower it." The author of the report, Donald P. Morgan, defined predatory lending as "a welfare reducing provision of credit." Results of the report indicated that payday loans may actually do the opposite by improving the welfare of the consumer.

[edit] Withdrawal from North Carolina

On March 1, 2006, the North Carolina Department of Justice announced the state had negotiated agreements with all the payday lenders operating in the state. The state contended that the practice of funding payday loans through banks chartered in other states illegally circumvents North Carolina law. Under the terms of the agreements, the lenders will stop making new loans, will collect only principal on existing loans and will pay $700,000 to non-profit organizations for relief.

[edit] Payday loans in Canada

According to the Canadian Criminal Code, any rate of interest charged above 60% per annum is considered criminal. On August 14, 2006, the Supreme Court of British Columbia issued its decision in a class action lawsuit against A OK Payday Loans. A OK charged its customers 21% interest, as well as a "processing" fee of C$9.50 for every $50.00 borrowed. In addition a "deferral" fee of $25.00 for every $100.00 was charged if a customer wanted to delay payment. The judge ruled that the processing and deferral fees were interest, and that A OK was charging its customers a criminal rate of interest. The payout as a result of this decision is expected to be several million dollars.^[2]

[edit] Neutral Government Information

The Canadian federal government publishes a booklet called The Cost of Payday Loans,^[3] which explains how payday loans work and the various fees and charges that can apply. The publication also illustrates the cost of borrowing using a payday loan, compared to the cost of borrowing the same amount using other credit products. The booklet is published by the Financial Consumer Agency of Canada.

[edit] See also

• Interest
• Usury
• Pawnbroker
• Title loan
• Loan sharking
• Predatory lending

[edit] References

[edit] Sources

• FDIC guidelines on Payday lending
• Community Financial Services Association of America - Payday lenders' trade association
• Supreme Court of the United States. Marquette National Bank of Minneapolis v. First of Omaha Service Corp. et al., 439 U.S. 299 (1978). Accessed on Findlaw.com. [1]
• "Defining and Detecting Predatory Lending" - Federal Reserve Bank of New York Staff Report [2]
• North Carolina Department of Justice (2006). Payday lending on the way out in NC (PDF). Retrieved on 2006-03-22.
• The Canadian Press (2006-08-14). B.C. court rules payday loan company was charging 'criminal' rate of interest. Retrieved on 2006-08-15.

[edit] External links

• Official site of the Community Financial Services Association [3]
• National television ad promoting responsible use of payday loans [4]
• CFSA Best Practices [5]
• "Defining and Detecting Predatory Lending" - Federal Reserve Bank of New York Staff Report [6]
• Payday Lending: Serving the Unbanked - Article by Mike Foley.
• In Defense of Payday Lending - Article by Tom Lehman.
• How the Other Half Banks - Slate.com's article on the payday loan business.
• Consumer's Union Fact Sheet
• Payday loan site of the Consumer Federation of America, a consumer advocacy organization
• Payday Loan Industry Watch - Industry-independent, neutral source for podcast interviews and news
• America's Growing Fringe Economy article discussing payday loans in Dollars & Sense magazine
• Barry Yeoman, Sudden Debt, AARP The Magazine
• The Cost of Payday Loans, Financial Consumer Agency of Canada