By Uriah King, Leslie Parrish and Ozlem Tanik Center for Responsible Lending

America’s working families pay billions of dollars in excessive fees every year, as payday lenders across the nation routinely flip small cash advances into long-term, high-cost loans with annual interest rates in the range of 400 percent.

Despite attempts to reform payday lending, now an industry exceeding $28 billion a year, lenders still collect 90 percent of their revenue from borrowers who cannot pay off their loans when due, rather than from one-time users dealing with short-term financial emergencies.

Based on data collected by state regulators, financial records released by payday lenders, and assessments by third-party analysts, CRL has updated our 2003 quantification of the cost of predatory payday lending to American families. Breaking down the impact by state, we have also calculated the savings to families in states that have banned payday lending.

In our report, Financial Quicksand, we find that:

• Ninety percent (90 percent) of payday lending revenues are based on fees stripped from trapped borrowers, virtually unchanged from our 2003 findings. The typical payday borrower pays back $793 for a $325 loan.
• Predatory payday lending now costs American families $4.2 billion per year in excessive fees.
• States that ban payday lending save their citizens an estimated $1.4 billion in predatory payday lending fees every year.

Ninety percent (90 percent) of payday lending revenues are based on fees stripped from trapped borrowers

New information from data provided by state regulators, payday lenders’ public filings, and assessments of third-party industry analysts confirms the payday lending industry’s continued reliance on loan flipping.

The typical payday borrower pays back $793 for a $325 loan

Taking the interest on the average payday loan principal as reported by state regulators, and multiplying it by the average number of loan flips per year, we find that the typical borrower ends up paying back $793 for a $325 loan.

Predatory payday lending now costs American families $4.2 billion per year in excessive fees

Counting the fees paid by borrowers who have five or more payday loans per year, which indicates they are caught in a cycle of debt, we calculate the 2005 costs of predatory payday lending in each state, for a national total of $4.2 billion per year.

States that ban payday lending save their citizens an estimated $1.4 billion in predatory payday lending fees every year.

Despite the spread of payday lending nationwide, a number of states have no known costs associated with the practice. We project the 2006 savings for states that ban payday lending at $1.4 billion, quite a significant level considering that these total savings are realized by fewer than a dozen states.

Conclusion and recommendations

Solving the payday lending problem has been a huge challenge for most states. The industry has successfully lobbied legislatures across the country to exempt payday lending from state consumer loan laws. In addition to legalizing the practice of holding a live check as collateral, these exemptions typically authorize interest rates at 10 times the interest rate cap provided for in the state’s consumer loan laws.

But there are signs that the tide is turning. The wave of payday authorization has clearly slowed, with states increasingly wary of this loan product. Several states have either refused to exempt payday lending from their laws or have closed existing loopholes.

Since the FDIC recognized the abusive nature of payday lending and tightened the reins on the banks they insure, the practice of national payday companies partnering with out-of-state banks (rent-a-bank) has all but disappeared. This places the responsibility for preventing predatory payday lending squarely in the hands of state legislators in the states where it is currently legal.

Some states have tried to reform payday lending by requiring databases, cooling-off periods, repayment plans or limits to the number of outstanding loans. The payday lending industry generally endorses these reforms, though we have found in the analysis provided in this paper that they have little impact on the debt trap payday lenders depend on for their revenues. Additional data is available from the states that have tried these reforms, which will provide the basis for a forthcoming CRL state-level analysis.

To solve the problem of high-cost payday lending effectively, state policymakers are increasingly applying their consumer loan laws to all lenders, including Internet lenders.

Most states have an existing interest rate cap in their consumer loan laws in the double digits; about a dozen are set at 36 percent. To prevent predatory payday lending, some states have refused to authorize special exemptions from these limits for payday lenders, whose business model requires them to charge triple-digit interest and repeatedly flip the loans.

Congress recently adopted, and the President signed into law, a 36-percent annual interest rate cap for consumer loans made to military families, protecting them from predatory payday loans as well as many other high cost loan products. The legislation outlawed taking a security interest in a live check, therefore prohibiting payday lending. The Pentagon reported that payday lenders are targeting their troops, and that servicemen and women are frequently losing security clearance because of their resulting debt problems.

Policymakers interested in preventing predatory payday loan flipping in their states should consider capping annual interest rates on small consumer loans at an all-inclusive 36 percent. This change would continue to allow responsible credit to flow, while saving Americans the billions of dollars now lost to predatory payday lenders.

© Copyright 2006 The Center for Responsible Lending. To see the full report, go to www.responsiblelending.org.

The Center for Responsible Lending is a non-profit, non-partisan 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.