An exploration of the most commonplace predatory lending scams destroying the futures of poor and minority Americans with impunity.
Part 2: Payday Loans – The Quicksand of Debt
The “perfect” loan for someone who needs an emergency cash injection now—and the most commonplace and devastating of the many forms of predatory lending—is the all-too-familiar “payday loan.”
Beware the payday loan. Plain and simple. It is a particularly cruel and dangerous method of borrowing. Of all the forms of predatory lending, this is the most confusing and ever-changing. It is also one of the most lucrative forms of exploitation. When lawmakers attempt to counter the industry’s reckless and deceitful lending practices, the lenders are often already several steps ahead of the new rules, looking for more loopholes and clever ways to drain the most vulnerable Americans.
So how do they do this? How are small little loans of, say, $500 so damaging to the borrowers?
Let’s start here. Though conventional banks and lenders are certainly no saints, often being sued and fined and probed for financial and ethical shenanigans, they are forced to play by a much different set of rules than smaller lenders who often don’t even describe themselves as lenders to avoid being regulated as much as possible. And, until fairly recently, with the creation of the Consumer Financial Protection Bureau, there have been virtually no rules or regulations for the payday lending industry.
Because of the lack of rules, what began as a boutique business idea in the mid-1980s started to slowly swell in numbers. By the early ‘90s there were just under 200 payday lenders in the entire country. During the height of the Great Recession, that number had exploded to over 22,000.
In my recent interview with Marc Dann, former Ohio Attorney General and current practicing attorney with Advocate Attorneys, an ally of AHP 75, I asked how it is that this niche industry grew into the sprawling and nefarious behemoth it has become today. “Prior to 2000,” Dann said, “most payday lenders were smaller operators who raised their own capital and collected their own debts. Wall Street figured out that they could also make a big spread on loaning money to these predatory lenders and massive cash was infused into the industry. They used that money to greatly expand their footprint around the country and on the emerging internet and invested millions of dollars in political contributions and lobbyists at the state and federal level.”
So many pounds of flesh out there just waiting to be had. So much desperation. So much poverty. In other words, a perfectly primed marketplace for predators.
According to a recent article in the Chicago Reader, in Illinois alone, there are roughly 1500 lenders who are truly hoping the recent law passed by our state legislature isn’t signed into law by Gov. Pritzker. Why? Because Illinois will join the ranks of only 17 other states who have moved to make it illegal to charge interest rates over 36% on consumer loans less than $40,000. While this might not seem to be a big deal, consider that payday loans regularly feature three-digit and sometimes—unbelievably—four-digit interest rates. How do they get away with this?
Of the many tricks, deceptions, and sleights-of-hand performed by payday lenders, the interest rate game is pivotal to their success. But that is only a small piece of the puzzle to understanding how a payday loan works, and why they are so dangerous. And so, what follows is a brief lesson on payday loans, from start to finish. Keep in mind, however, that these are only the most commonplace tactics used by payday lenders. They are by no means the only methods of manipulating and harassing borrowers.
(For a more thorough breakdown of the mechanisms of payday lending, the article “Usury Country: Welcome to the Birthplace of Payday Lending,” and the National Consumer Law Center 2020 report on predatory lending throughout the United States are both wonderful resources. Keep in mind that rules and regulations vary by state, and therefore the manner in which predatory loans work where you live could be dramatically different than a neighboring state.)
Tricks of the Trade:
Why are they called payday loans? Primarily because the first rule of these loans is that you must have a job, prove it with pay stubs, and then take out a loan against your upcoming paycheck. You write a post-dated check, leave it with the lender, and then they cash it on the day you get paid. Seems simple enough, right? Wrong.
The Origination Fee is where the games begin. Lenders will charge, say, $25 as an origination fee on a $250 loan, so that the post-dated check you write them will be for $275. (Many lenders these days, however, don’t actually accept post-dated checks, but would prefer to do a direct withdrawal from your checking or savings account, which is another issue altogether.) These fees vary widely state to state and from lender to lender, but they are one of the most important aspects to look out for. Because what happens later, when the debt cannot be repaid on time, is where the origination fee matters most.
The Interest Rate seems like a simple enough concept to most people. But, in reality, it can be a notoriously deceptive and horrifying method of making the loan impossible to pay. Of course, anyone who sees an interest rate of 976% on a contract would never sign such an agreement. But that’s not how it’s done. When most consumers think of interest rates, we think of APR, which is an annual rate of interest over the lifetime of the loan. APRs on payday loans are usually shown as relatively low, as illustrated in several examples given in the NCLC report. But the vast majority of payday loans charge an additional daily interest rate, which is where the math gets both confusing and horrific. Take the aforementioned $250 payday loan. If it has an APR of 24% plus a 7/10ths of a percent per day, the true interest rate comes out to a whopping 279% percent. Yes, it is confusing. And that is by design. This is just one of countless interest rate bait-and-switches pulled in the industry, and the methods vary as widely as the lenders themselves.
Late Fees are another area where the payday loans become dangerous. While a late fee might seem reasonable and fair, the amounts vary widely. And they are rarely reasonable or fair. Often, along with the origination fees, late fees (and other creative fees sprinkled here and there) far outstrip the stated interest rate of the loan itself. In payday lending, the name of the game is fees, fees, fees. But why?
Because the true game, the real hustle—the bread and butter of the entire industry—is the people who cannot pay the loans and therefore have to rollover or renew the original loan. And, as the game intends, nearly 80% of borrowers end up rolling over their loans.
So. Much. Flesh.
When it comes time to rollover the loan, the entire amount (all those fees, interest, original amount borrowed) is repackaged as a new loan with new interest and new fees, and so the original loan’s fees and interest quickly multiply into nearly insurmountable costs. A Gordian Knot of debt.
Stories abound of unwitting consumers being roped into these endless rollovers, where a loan that began in the hundreds of dollars easily ends up in the thousands. One shocking (but not uncommon) example outlines the story of a woman who took out a $300 loan, and, after 24 rollovers of the original loan, ended up over $15,000 in debt. The rollover or renewal is the reason why, as mentioned earlier, predatory lenders do not want you to be able to pay off your debt. If you cannot pay off your debt, then you are virtually forced to renew the loan and double down on the debt. And so begins the spiral of debt stemming from one simple little loan.
This form of predatory lending affects all Americans. In fact, while working to lobby Ohio legislators for better regulations to combat payday lenders and other predators, Marc Dann was horrified to learn there were even people among the lawmakers themselves who had currently active payday loans.
“I’ve known doctors and lawyers, people with substance abuse problems, people who have had a medical emergency,” said Mr. Dann. “This is not just a problem for the very poor.”
But, as the 2020 NCLC report found, these types of loans disproportionately effect people of color and the lowest income Americans.
And for those who cannot pay? For those whose checks bounce or automatic withdrawals are refused for insufficient funds? Dann recounted how he and his colleagues watched as “over time the more sinister payday lenders emerged literally holding signed checks of my clients until their designated payday and then threatened to cash those checks (which would bounce) and prosecute the borrower for check fraud if they didn’t continue to roll the loan over into another high-interest, high-fee loan.”
Another final slap to the face of uninformed borrowers? The fact that most payday loans carry with them mandatory arbitration clauses that make it impossible for clients to band together in a class action suit against their company for any of their harassing and predatory practices.
The CPFB was supposed to address tactics like this head on. And, according to Dann, they were “getting ready to drop the hammer” on predatory lenders under the leadership of former Director Richard Cordray, an Obama appointee. But then, like so many other well-intentioned laws, regulations, and agencies, the CFPB was subsequently gutted and rendered impotent by clever legal and financial workarounds, as well as intense and relentless pressure from industry lobbyists. It didn’t help that when Trump was elected, he quickly removed Cordray and installed a new CFPB Director, Mick Mulvaney, who promptly went to work dismantling the bureau piece by piece.
“The political apparatus of the payday industry had a field day with the Trump-appointed administration,” said Dann.
And just how much of a field day did the payday lending industry have under Trump? This final ruling, made by the CFPB in July of 2020 illustrates how absurd the notion of CPFB became under the Trump administration’s watch. The “rule” is anything but consumer protection. Take a moment and read it for yourself.
It is actually a revocation of the most important aspect of the “Payday, Vehicle Title, and Certain High-Cost Installment Loans” Rule, which was officially issued October 5, 2017. Under the directorship of Cordray, this rule was specifically designed so that predatory lenders must be able to ensure that their customers could actually afford the loans being given.
As soon as Mulvaney was made Director of CFPB, he quickly zeroed in on this particular rule, officially proposing to rescind the implementation of the mandatory underwriting provisions—the part of the rule that required lenders to ensure their customers could afford the loans—setting the stage for its complete revocation last year. That very same day, the CFPB also proposed to delay the compliance date of the 2017 rule. [Incidentally, the last two links are correct. The CFPB simply removed the documents from the website. See “Key Milestones.”] These were shameless stall tactics that allowed predatory lenders to continue unchecked while the Mulvaney-led CFPB went to work on rescinding the rule entirely, which is the official stance of the CFPB to this very day.
And so, the one thing that might have actually finally put a reasonable barrier between predatory lenders was destroyed.
More of the same. More of the same. More of the same.
The Goliath is outmatching the David in this fight. Plain and simple. Senator Elizabeth Warren, one of the architects of the CFPB, noted the bureau’s importance in a recent New York Times article: “people got in over their heads not because they were greedy or lacked self-discipline, but because they were being outmatched by a sophisticated and often predatory industry of lenders.”
Obviously, it is best for consumers not to even go down the path of payday lending. But if you’re desperate, it might seem to be the only possibility. Make it an absolute last resort. Your entire financial future might be at risk.
However, if you do decide to go that route, do so with your eyes wide open to the sinister methods these predatory lenders employ. The pull of the payday loan orbit is practically unshakable. The debt trap is real. And it is devastating.
I asked Mr. Dann for any other potential options for people who need money in an emergency, for any realistic alternatives to falling into the spiral of payday loans, and he had this to say: “Don’t take these loans to begin with. Borrow from family and friends and/or your boss. Find a side hustle. Take a second job. Look at how you can increase income or cut costs. If you are at the end of your rope, reach out to local non-profits like United Way or Catholic Charities who often have loan/grant programs for emergencies. If you do [take out a payday loan], don’t be tempted to roll them over. If you are over your head, consult with an experienced consumer protection lawyer. It’s better to default and consider bankruptcy options or options to sue or seek arbitration than to double down and get stuck in the spiral.”
In other words, try to keep your flesh to yourself.
Caught in a downward spiral of debt? Visit AHP75.com to learn about our Debt Remediation Services.
Aaron Morales is the Social Justice Writer for AHP 75, based out of Chicago, IL.