Payday lending bears some relationship to the century-old practice of “salary buying,” a credit transaction in which a lender would buy at a discount the borrower’s next expected wage payment. The practice of extending a postdated check dates back at least to the Great Depression, according to the Consumer Federation of America.
As the spread of direct deposit and electronic funds transfer technologies showed the growth in the demand for check cashing services, some check-cashing outlets became direct credit providers, but payday lending was a sideline to their primary business of cashing checks for a fee. The explosive industry growth that began in the 1990s was demand-induced – as the market for short-term, small-denomination credit soared – and a function of large regional and national payday lending entities entering the market.
An Overview of the States
National data on the payday loan industry is not readily available. That the national payday loan market reached $50 billion by 2004 is based on industry estimates, as is the forecast that market maturity will occur at around 25,000 outlets and gross loan fees of around $6.75 billion.
The number of payday outlets without a credit score in Ohio (1,408) and Oregon (356) doubled over the past four to five years, while almost tripling in Arizona (610). Over the past decade, the number of outlets has grown more than twenty-fold in Utah (384) and ten-fold in Kansas. California went from zero payday lenders in 1996 to 2300 in 2004, with almost 450 new outlets opened in California in 2003 alone.
From the standpoint of the number of loans made, the growth rate of payday lending without credit checks and due dates is also impressive. Missouri’s 2.6 million payday loans in 2004 represented an increase of 30 percent over the previous year. From 2000-2003, the number of loans in Washington state grew from 1.8 to 3.0 million.
Between 2002 and 2003, payday originations in Florida increased by an average of 1.9 percent per month and by another 18 percent the following year. In Oregon, between 1998 and 2003, payday loan originations grew by 235 percent to a total of more than 677,000 advances while in Texas, where payday lending was first legalized in 2000, suppliers found a ready market for about half a million loans in 2001, more than 1.0 million in 2002, and 1.8 million in 2003.
Payday Lending Industry
The payday lending industry remains fairly fragmented, although it has experienced some consolidation in recent years driven by economies of scale and the ever-expanding capacities of information and communication technology. More mergers seem to be coming in the payday loan industry, as smaller, independent operators sell to regional and national companies who focus on high interest, personal loans, additional fees, and monthly payments.
A few cases in point: in Illinois, five companies own 37 percent of all outlets; in Florida, 10 companies own 71 percent of all stores and generated 81 percent of all transactions; while in Washington state, four companies accounted for 55 percent of loan volume. Nationally, by the late 1990s, ten chains controlled more than one-third of all payday loan outlets. Currently, six large companies control about 20 percent of all payday lending activities. The nation’s largest payday lender is South Carolina-based Advance America, which operates more than 2,600 stores nationwide.
The others are Dallas-based ACE Cash Express Inc., which operates a network of 1,557 stores in 36 states and District of Columbia; Check ‘n Go, based in Ohio, which has 1,322 payday-loan outlets; Texas-based Cash America, which has 741 pawn and cash advance locations; Pennsylvania-based Dollar Financial, which has 725 company-operated financial services stores as part of an international network of 1329 stores; and Tennessee-based Check Into Cash, which has over 1200 outlets in more than 30 states.
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The Demand Side
About 5 percent of the U.S. population has taken out at least one payday loan at some time according to the Consumer Financial Protection Bureau. A payday loan or cash advance loan primer from an industry-supported think tank reports that more than 24 million Americans – about 10 percent of the adult population – say they are somewhat or very likely to obtain a payday loan without credit counseling (Consumer Credit Research Foundation).
Most payday customers are highly credit-constrained. Nearly all payday loan customers use other types of consumer credit, and relative to all U.S. adults, three times the percentage of payday loan customers are seriously debt-burdened and have been denied credit or not given as much credit as they applied for in the past five years.
Payday loan customers are also about four times more likely than all adults to have filed for bankruptcy. Over half of current payday loan borrowers report that they already have an outstanding payday loan.
The core demand for payday loans originates from households with a poor credit history, but who also have checking accounts, steady employment, and an annual income under $50,000. Advance America’s average customer is 38 years old with a median household income of just over $40,000.
In addition, 42 percent are homeowners, and 84 percent are high school graduates. In Indiana, state regulators report payday loan customers to be in the $25,000 to $30,000 income range. In Illinois, the average is $24,000 while borrowers in Wisconsin are even less affluent with an average income of just $19,000.
Certain groups are more likely to take out payday loans than others. For example, active-duty military personnel is three times more likely than civilians to have taken out a payday loan. One in five active-duty military personnel were payday borrowers in 2005.
To protect military borrowers Congress passed a measure banning payday loans to service personnel on active duty and their families effective October 1, 2007, and capped interest rates on other unsecured consumer loans at 36 percent annual percentage rate, which is the same maximum rate specified in the small loan laws of many states.
Texas payday lenders also tend to concentrate in counties with high proportions of minority residents and poverty. In Cameron Country, where 85 percent of the 335,227 residents are minorities and one-third live in poverty – the county has 115 payday lending stores and just 64 bank branches. By contrast, in suburban Collin County (northeast of Dallas), where only 24 percent of the 491,675 residents are minorities and only 5 percent are poor, there are 30 payday lending outlets and 155 banking offices.
Using Laws To Protect From Payday Lenders
Using zoning powers to prevent payday lenders from clustering in or near residential neighborhoods is being tried in Arizona – more for its nuisance value than anything else. For example, South Tucson requires new payday-loan businesses to be a quarter of a mile from other payday-loan shops and 500 feet from homes or residentially zoned properties, while a pending Phoenix law would require payday outlets to be at least 1,000 feet from each other.
Because chronic borrowers patronize more than one payday lender at a time before the next payday, borrowing from one to pay off another, the limitations on clustering may decrease customer convenience, and make it more difficult for some lenders to secure prime sites. By and large, local officials recognize that they can’t change basic industry practices through zoning, but frustrated by the inability to convince state lawmakers to take more restrictive actions, they are trying to use the legal power available to them.
Frustration with state inaction led the Common Council of Wauwatosa, Wisconsin, a Milwaukee suburb, to try using land use controls to thwart local growth of payday lending. In September 2006, the council decided to impose a one-year moratorium on check-cashing, payday loans, and similar businesses in some locations while they considered a measure to restrict them to certain locations.
Efforts to distance payday lenders from clustering around military bases with unexpected expenses have also occurred, especially since the Department of Defense has requested that governors and state legislators help to protect service members from payday lending.
The preferred policy choices will vary according to whether payday loans are viewed as a tolerable high-cost form of emergency short-term credit, or whether they are viewed as a loan at triple-digit annual interest rates. Concern over chronic indebtedness from repeat borrowing trumps other public policy concerns with payday lending by a wide margin. About 40 percent of payday loan customers rolled over more than five loans in the preceding 12 months, including 10 percent who renewed an existing loan 14 or more times.
In the course of site examinations of licensed lenders, Illinois regulators found evidence of customers who were borrowing continuously for over a year on their original loan. More recent data from Florida show the same trend. The average number of transactions per customer between October 2004 and September 2005 was 7.9, with more than a quarter of all customers taking out twelve or more advances in a single year.
In Oklahoma, the average number of transactions per borrower between October 2004 and September 2005 was 9.4. Approximately 26.8 percent of customers took out twelve or more loans with finance charges during the period, accounting for 61.7 percent of total transactions.
Most reforms of payday lending revolve around efforts to reduce serial borrowing. Twenty states now limit the number of advances a borrower can have outstanding at any one time. Thirty-one states limit rollovers. Seven states provide mandatory cooling-off periods between loans that range from the next business day after two consecutive loans are repaid in Alabama, to seven days after five consecutive loans are repaid in Indiana.
Other attempts to limit serial borrowing are more complex. For example, New Mexico state law now limits consumers to just two back-to-back renewals at a maximum fee of $15.50 per $100 advanced, with the maximum advance set at a total payment not exceeding 25 percent of the borrower’s gross monthly income.
Short of banning payday lending altogether, Illinois has enacted the most restrictive reform measures in the country. Similar to New Mexico, Illinois caps payday loan fees at $15.50 per $100 and also caps total loan amounts that a borrower may have outstanding from all lenders at any one time at $1,000 or 25 percent of the borrower’s monthly salary, whichever is less. Illinois borrowers may also opt for a repayment plan rather than having to repay the loan all at once, thus converting a payday advance into an installment loan. The Illinois law also requires a 14-day cooling-off period after completion of a payment plan before a borrower can take out another short-term loan.
Illinois also joins Florida and Oklahoma in requiring lenders to report customer loan information to a central database and to consult the database before making a new loan to their bank account before their next paycheck. Because of the high prevalence of serial borrowing from multiple lenders, any serious regulatory effort to limit chronic borrowing should include such a database, yet only a few states currently require it.
The political clout of the payday loan industry in statehouses across the country is reflected in the rising number of states that explicitly authorize payday lending, from 23 plus the District of Columbia in 2000 to 38 in 2005. However, more recent political sentiment seems to be moving against the industry. For example, Delaware exempted payday loans from the state’s civil bad check statute, there denying lenders bounced check fees when payday loans fail to clear the customer’s account.
Regulators Force Evolution Of Payday Loan Business Model Into Out Of State
Controversy has surrounded payday lending ever since its emergence as an important player in the summer credit market, and in a kind of multidimensional chess game, the industry has challenged each new wave of regulations and, when unsuccessful, modified its business model accordingly.
The Rent A Bank Model
In the late 1990s, many states began to clamp down on high loan fees, which precipitated a dramatic change in the payday loan industry’s predominant business model. In an effort to circumvent state fee caps, payday loan companies began partnering with out-of-state national banks that are allowed under federal banking laws to export the interest rate of their home state into another state.
The Depository Institutions and Deregulation and Monetary Control Act of 1980 allows state-chartered banks and other financial institutions accepting federally insured deposits to do the same. Thus, when payday lenders began partnering with banks, payday loans became “bank loans,” and thus not subject to state-imposed fee caps or usury laws.
Internet Payday Lending
Payday lenders have been experimenting with online products and using the Internet as a cost-effective delivery channel, although this channel has yet to achieve the popularity of either the stand-alone payday lender or the rent-a-bank model. In Massachusetts, where payday lending is illegal, banking regulators issued more than 90 cease-and-desist orders to out-of-state payday lenders who were using the Internet to make loans in that state.
In May 2006, the Massachusetts Office of Consumer Affairs’ Division of Banks issued 48 similar orders against out-of-state payday lenders who were marketing illegal loans to Massachusetts consumers through the Boston Craigslist website and in the Boston Herald. Finally, shortly after the North Carolina payday lending law was allowed to expire in September 2001, a local payday lender reopened its doors, offering Internet service to customers, who got an immediate “rebate” of up to $500 in return for agreeing to pay periodic fees of $40 to $100 per month for a few hours of Internet access at the provider’s office computer for a few hours a week.
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What Should Policymakers Do?
A recent national survey of American adults shows that the public is more worried about falling into debt, particularly through medical bills, than about being a victim of a terrorist attack or natural disaster. In addition, only half of the survey respondents were able to pay off their entire credit card bill every month. The sharp rise in payday lending is both a symptom and a cause of these concerns over credit.
The rise and phenomenal growth of the payday loan industry required both strong market demand for such loans and a compliant regulatory system that exempted the fees that lenders charge for holding postdated checks from state usury laws and interest rate caps. This regulatory climate also allows bounce protection and assorted other bank fees and penalties from which banks profit so handsomely, and these profits discourage mainstream banks from under-pricing payday lenders in a head-to-head competition.
In setting these rules, policymakers and regulators must be mindful that setting caps on fees or setting implied interest rates arbitrarily low could easily curtail or eliminate the flow of credit to the high-risk borrowers who need it most. Policymakers and regulators should focus more of their attention on ways to limit rollovers and back-to-back renewals of payday loans, rather than focusing on the price of a single short-term advance.
Research and evidence on payday lending need to catch up with anecdotes and polarized arguments. There is almost no empirical evidence on how some of the main policy options would affect the demand, price, and use of short-term credit. This is true for zoning regulations to lessen customer convenience and access, the lengthening of minimum payback periods, the introduction of an installment option, credit union options, limits on rollovers and renewals, and the other options that would effectively end payday lending.