Is the payday loan business on the ropes?

By John Sandman
September 21, 2012

Payday lenders have a lot in common with pawn shops, their close cousins: They depend on lending money to desperate people living close to the edge with nowhere else to turn. They first surfaced about 20 years ago in the South and Midwest, often as small mom-and-pop shops. Now the industry is dominated by large national chains, with some 20,000 storefronts nationwide. Coming out of the shadows of cyberspace, however, are Internet lenders, which are like storefront lenders on steroids.

The average payday loan is tiny, about $400, and in the benign view of the industry, it gives customers with trashed credit scores, who lack other credit options, emergency cash until their next paycheck arrives. But according to the Center for Responsible Lending, lenders charge a mind-boggling 391 to 521 percent interest for loans that have to be paid off in two weeks, often triggering a toxic cycle of debt, as borrowers take out fresh loans to cover the old ones. Internet loans are bigger, generally charge a higher annual percentage rate and, consequently, are more expensive than their storefront counterparts.

As non-banks, payday lenders have so far escaped federal regulation, leaving a hodgepodge of state laws as the only bulwark against these usurious loans. If the storefront lenders have been hard to regulate, Internet lenders have been even harder to find, as they make loans to lenders in states where they’re banned by setting up servers offshore or in states where they are legal. Industry experts put the number of online lenders in the hundreds, so far, but one website can reach many more people than a storefront. A January report from San Francisco-based JMP Securities estimated that market share for Internet lenders would hit 60 percent by 2016.

Some attorneys general in states with payday bans, like New York and West Virginia, have sued individual lenders for targeting residents in their states. A 2009 settlement by then-Attorney General Andrew Cuomo with two out-of-state Internet lenders was one of the few cases to force lenders to make restitution to scammed borrowers — 14,000 of them. But the lenders simply resurfaced in some other form.

Richard Cordray, chief of the new Consumer Financial Protection Bureau, has pledged to focus on the industry and held a public hearing on payday lending last January in Birmingham, Alabama. Yet he has been mum on new enforcement plans as the politically besieged bureau sets it sights on more mainstream products such as mortgages, credit cards and student loans.

But could the Federal Trade Commission come to the rescue? Established in 1913, the FTC has recently watched the CFPB steal some of its thunder, but it may be on the verge of not only holding these lenders accountable but also possibly shutting them down.

The FTC began suing cyberspace lenders about five years ago in a flurry of cases, mostly related to fraud or failure to disclose loan terms. Websites came with deceptively labeled buttons that led you to falsely advertised products. One wrong move with your mouse and you just paid $54.95 for a debit card with a zero balance when you thought you were getting a payday loan, witness FTC vs. Swish Marketing. One of the most spectacular examples is the FTC’s recent suit against call centers in India, such as American Credit Crunchers, LLC, that harassed people to repay Internet payday loans they had never even taken out — sometimes even threatening people with arrest. The FTC alleged that the defendants fraudulently collected more than $5.2 million in payments on these phantom loans.

But a new FTC case, against Kansas-based payday lender AMG Services Inc, may set a precedent that topples this house of cards. Earlier lawsuits sanctioned lenders, but didn’t prevent them from returning to the same scams once they settled with the government. What’s different about the AMG Services case is that the FTC goes after the foundation of Internet payday’s business model — the demand that borrowers give lenders access to their checking accounts as a condition of getting a loan. Once the lenders had control of the accounts, they had unfettered access to the borrower’s money and could withdraw money at will — something that borrowers typically don’t understand when they accept the loan. The borrowers were powerless to put a stop to this once they realized what was happening.

“The defendants told consumers that the total amount required to repay the loan will be the amount borrowed plus a one-time finance charge to be automatically withdrawn on a single date,” said Nikhil Singvhi of the FTC’s bureau of consumer protection and lead attorney on the case. “But contrary to those representations, the defendants initiated multiple withdrawals from the consumers’ bank account, assessing a new finance charge each time.”

Stopping the withdrawals was futile. “Consumers would call their bank and say I don’t want these withdrawals processed anymore,” Singvhi says. The bank would request a letter revoking that authority — sent to the bank and the lender — and still the withdrawals kept on coming.

For example, one plaintiff in the suit took out a $300 loan, expecting to pay back the principal, plus a $90 fee, in two weeks. Instead, the lender withdrew a $90 fee for each of the borrower’s next four pay periods, without touching the loan principle. After that, the principal was drawn down in small increments, always with more accompanying fees. By the end, the payments totaled $975. That’s $675 in fees instead of $90 — an extraordinary windfall when factored out across countless loans. Many consumers closed their accounts in desperation.

If the FTC wins its case, the impact on the lenders’ cash flow — and profits — will be significant, if not extreme. If the ability to extract payments by means of electronic funds transfers that extend the life of the loan while fees rapidly mount is what this industry is built on, there could be an industrywide shakeout from which the industry may not recover.

The FTC suit alleges that requiring payment by means of an electronic funds transfer is itself a violation of the 1968 Electronic Funds Transfer Act, which forms the basis of their case. “I think they’re on solid ground,” said Moira Brennan, head of the New York City-based Brennan Law Group, which handles consumer issues. “The Act states that you can’t require an electronic funds transfer as a method of payment.”

Lauren Saunders, managing attorney for the National Consumer Law Center, says the ETF Act would not apply if lenders closed customers’ loans on a single withdrawal, covering both principal and fee. But once they make multiple withdrawals, the Act is violated. And those multiple withdrawals that don’t touch the principal are exactly what make Internet payday loans so profitable. As Saunders says: “Many, if not most, Internet payday loans are structured to pay only the fee at regular intervals for a period of months before the loan is repaid.”

The Online Lenders Alliance, an industry trade group, has no doubt smelled a public relations problem and is coaxing member firms to install a button on their websites for customers to click if they think they’ve been victims of fraud. It is a “public awareness campaign,” says OLA spokesperson Peter Barden, who believes that there is nothing wrong with this industry that the industry itself can’t fix. Customers, he says, “could click through to an OLA Web page that would report it.”

Barden could not say how complaints would be acted upon and couldn’t identify any members who had added the button. But identifying a few bad apples is beside the point. If this source of profit disappears because the FTC prevails in its suit, there could be little — if anything — left to reform.

For years, consumer advocates have witnessed federal inaction and failed attempts at the state level to rein in the industry. Perhaps the FTC will begin to provide results.

PHOTO: The judge’s gavel is seen in court room 422 of the New York Supreme Court at 60 Centre Street February 3, 2012. Picture taken February 3, 2012. REUTERS/Chip East

16 comments

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How is it possible that such a scam was allowed to happen in the first place ? Where in the world are our respected law enforcement people ?

‘For years, consumer advocates have witnessed federal inaction and failed attempts at the state level to rein in the industry.’

Gangsters are running our country.

Posted by EthicsIntl | Report as abusive

“As non-banks, payday lenders have so far escaped federal regulation, leaving a hodgepodge of state laws as the only bulwark against these usurious loans.”

What a load… Same old uninformed attack on the payday loan industry. There are a multitude of federal laws that apply and 33+ states having specific enabling legislation.

The supposed credible “Center for Responsible Lending” is funded by credit unions and other competitors to payday loan products. “Follow the money…”

“…scammed borrowers — 14,000 of them.” Another “load.” Had Mr. Sandman made an effort to due the research, he would know the rates and terms are clearly disclosed in 14 point fonts and definitive fees.

I could go on but it’s useless. Just the same old garbage regurgitated by the press.

Bottom line, 14,000,000 U.S. residents requested a payday loan last year. Why? Because they needed access to quick, no-hassle small dollar loans. Is ANYONE at the CRL willing to reach into THEIR pocket and loan a few hundred bucks to a consumer who has zero collateral? So they can fix their car and get to work? Pay for their prescription? Keep the lights on?

Obviously NOT!

Jer – Trihouse (And yes, I’m a proud Lender)

Posted by Jer-Trihouse | Report as abusive

Gee, I thought usury was illegal, but I guess not in a truly free market capitalist country.

Posted by borisjimbo | Report as abusive

In a capitalistic society, who are the top officials in any regulatory agency? Why, or course, they are the top executives of the top companies in that industry.

Thus bankers themselves own the SEC, the Fed, and every other agency that might possibly regulate payday lenders. They see them all as brothers.

Posted by AdamSmith | Report as abusive

This is what smaller government looks like. If you like what you see vote GOP.

Posted by IntoTheTardis | Report as abusive

There are always loopholes, and rats will always find a way to get to the goodies. Look at how gambling at internet “cafes” has proliferated, with little enforceable regulation to rein in blatant profit-taking.

LOL: “If you like what you see vote GOP”… We were just having this discussion with our teenager, about how the Republican party tends to the Darwinian “If they’re stupid, let them get pulled under by market forces”, versus the Democratic “safety nets for everyone” approach. Sometimes there is no good answer for injustice, other than “shine a light on it and, if you can pin it down, then burn it out”…

Posted by flared0ne | Report as abusive

First lets get something straight. The so called “Victims” are not being forcibly dragged into these “establishments” any more than online porn watching children accidently “stumble upon” pictures of topless women. In virtually every case. these people purposefully make rational (at least in their minds eye), reasonable and honest mistakes. Yes there are exceptions to all rules but lets not go there.

I am a recovering Ronald Reagan born again Christian-Libertarian-Protesting-Ant of the Luther/Gutenburg/WASP bible kind. I hate daGubamint with a passion but love all Men and Women. Remember as a Life Member of the LP Ive sworn off physical and even poltical violence so we are just debating here. Please BE offended but don’t hurt me for telling YOU what I see as the truth.

The key is to quit asking legislator/regulators to prevent self destructive individuals from hurting themselves and demand that Government do its job by actually prosecuting and punishing real Crooks and Criminals in way that hurts them not society or the taxpayers.

Try this. Lets go back to the idea of making it perfectly OK for any citizen to leave behind a $20 Bill, the car and house keys in a plain paper envelope addressed to Federal Bankruptcy Clearing House. After 7 years ALL outstanding debts – yes even those nasty student loans and IRS penalties – are forever gone. Kinda like the old Jewish Bibles tell ALL money lenders to Just Do That!

That, ie loosing their “investments” would and should cause banksters to fail (no FDIC Insurance funded by the little people either.) I hear that the joys of Hobo Tent Camping or Couch Surfing on empty stomachs comes close to what Privatized Federal Drug Prison life is like. So That’s fair too.

Posted by GLsword | Report as abusive

They aren’t being dragged into these establishments, but force or violence are not per-requisites for crime. All manner of cons and scams are illegal; it’s simply lack of judicial agility that leaves this behavior technically legal in most states.

Posted by spall78 | Report as abusive

Sadly, what could be an educated and informed voice acknowledging the new realities in the dynamic world of financial services has chosen instead to trot out an old and tired opinion of miscontrued facts.

Consumers who willfully, and inteligently chose to use the time and place convenience of online access to short term credit products 1) do so with ample sources of supply agressively competing for their business; 2) don’t have “trashed credit scores” but are often well above the credit cut-off scores for traditional sources of credit like banks and credit unions; and 3) clearly know that a short term loan is a cheaper alternative to many other options inlcuding bank and retailer NSF fees.

Short term lending is a legitimate service meeting an increasing demand in this country. It is a highly regulated actvity on both the state and federal levels. Well placed and approptiate efforts by those regulatory agencies to ensure compliance may, in fact, be appropriate. What is inappropriate are less than accurate opinions being touted as fact, or individual events or firms being construed as representative of an entire industry.

Posted by Longitude | Report as abusive

Access to credit for distressed borrowers is considered “microlending” on the one end and “predatory lending” on the other; it’s all a matter of perspective. But a lot of the proposed rules and policies don’t make that distinction. The Center for Responsible Lending certainly considers payday loans to be predatory (unless you’re getting that loan from a credit union: http://www.bloggernews.net/120329).

Regardless, small dollar lending is an emerging market. Whether you’re getting a loan from Muhammad Yunnis or the local payday lender, if you use these opporunities wisely, they can be a means to the end of improving your credit and thus your prospects for a better life. But in the narrow attempts by groups like the CRL to snuff out payday lenders, they are creating regulations and rules that will make all forms of subprime credit unavailable to those that can most benefit from it.

Posted by PaperChaser | Report as abusive

Lenders are not looking to “escape federal regulation.” In fact, we are one of the few industries asking for it.

The bipartisan Consumer Credit Access, Innovation and Modernization Act will establish a federal charter that clearly defines a set of transparent national standards, allowing lenders to provide more credit alternatives with lower costs as well as flexible payback periods and loan amounts.

Nonbanks operating under a federal charter will have to comply with all federal laws and regulations applicable to other bank lenders, including the consumer protection authority of the Consumer Financial Protection Bureau. We are asking every lawmaker to seriously consider this legislation so that millions of Americans will have access to the kinds of innovative financial options that they’re demanding.

Meanwhile, the Online Lenders Alliance will keep working to stop deceitful and fraudulent practices.

Since OLA was established in 2005, we have been working with the FTC and law enforcement agencies to protect our customers. In fact, we helped the FTC bring down an agency that collected phantom short-term loan “debts” that consumers did not owe. And we also hired Freeh Group International Solutions, a global risk management firm, to investigate fraudulent practices reported to OLA.

It isn’t about a perception problem; it’s about doing right by those who use our products.

Lisa McGreevy
President & CEO
Online Lenders Alliance

Posted by LisaMcGreevy | Report as abusive

I really hope not! cashloancity.com saved our butt twice this year already.

Posted by royg6852 | Report as abusive

The media and payday loan opponents love to throw out interest rate numbers to shock the average person. “391% interest! That’s criminal! Predatory! Loan sharking!”

The reality is that 391% rate averages out to about $15 interest on a $100 payday loan. Now let us have some perspective…an overdraft fee from your bank is typically $34. A reconnection fee for utilities may be $50. A late-payment fee on a credit card is typically $25. The payday loan fee is actually the cheapest and most reasonable fee out of all of them.

Payday loans have their purpose. They exist so that people who cannot otherwise obtain a favorable loan through a traditional bank can cover unexpected expenses. They are not “unfair” or “predatory” in any sense.

Posted by cjanssen83 | Report as abusive

Payday loans in my opinion are another scheme for the richer to get richer and the poorer to get poorer. The poor need money so the rich will lend it to them on the basis that it is paid back with a huge interest rate. By the time the poor person gets their paycheck, they already owe it all to the rich person. This is completely different with respect to business cash advances. See http://wwww.capitalformerchants.com/cash -advance.php

Posted by MerchantMaster | Report as abusive

Not that I am an authority on the subject, but I believe that there IS indeed a need for such loans within our financial infrastructure. Granted, there are perpetrators in that industry that commit heinous acts like the frauds noted in the article above, but as I have read here many people responsibly make use of the services of honest payday lenders like Amscot and Advance America, to name just a few, every single day.

Yes, I do in fact believe that the criminals within the payday loan industry should be punished without prejudice, but to say that the entire industry was built for the sole purpose of essentially preying on individuals on the edge of insolvency is grossly erroneous.

Posted by Michael-Smith | Report as abusive

Payday loan is not a scam at all. It’s a means of getting emergency cash loans when needed. Traditional loans can not be availed anytime. That’s why payday loans are becoming popular day by day.

Posted by SandyUSA | Report as abusive