The Granddaddy of all Rip-offs

by Don Kuehn

A working mother without health insurance watches helplessly as her 11-year-old "takes one for the team" at a Little League game. She has to rush her son to the emergency room and then to the dentist for treatment. Unfortunately, even after bartering over the charges, the dentist insists on payment--in cash.

With no savings for emergencies, the woman sees no way to get her hands on the needed funds. Then she hears one of those chipper, happy-talk ads on the radio promising easy access to quick cash. That's it, she thinks, and she takes out a so-called payday loan.

Need a hundred bucks for two weeks? Simple. By showing a pay stub and post-dating a personal check for about $117.50 (the highest rate I could find in my Internet search), you can walk away with the money you need. Come back after payday with the money, and your check is returned. Seems harmless.

However, people who need to resort to this kind of borrowing already are stretched to the limit just trying to make ends meet every month. They are in no position to pay the loan when it's due and are intimidated by the thought of harassing collection practices, threats of jail or other dubious tactics. Lenders are more than happy to "roll over" the note for another pay period and another $17.50 or so. This happens not once, but typically several times.

The nationally recognized way for consumers to compare loan rates is what's known as APR (annual percentage rate). That seemingly harmless $17.50 charge amounts to a staggering 911 percent for one week, 456 percent for two weeks or 212 percent for a one-month term, according to Consumers Union, the nonprofit publisher of Consumer Reports magazine (go to http://www.consumersunion.org/finance).

Lenders say they charge such high rates because they take considerable risk by lending to people with high rates of default. But the statistics in Colorado, one of the few states to collect actual data on the industry, belie that notion. Only 3 percent of all loans were charged-off compared to 2.7 percent charge-off rate for credit card debt by banks.

Critics say the loans trap many people in an endless cycle of debt as they roll over loans or take additional loans to repay the first. Even in states that prohibit multiple loans from the same lender (i.e., using a new loan to pay off an old one) nothing prevents the desperate borrower from going to multiple outlets, digging themselves even deeper in debt.

When this practice started, the industry argued that loans would be used for short-term borrowing in emergencies. This has proven not to be true. According to a Wall Street analyst covering the industry, "the average customer makes 11 transactions a year." It's like an addiction.

A payday lender in Colorado estimates that only 2 percent of his customers take out only one loan, and he "expects all of [his] customers to default eventually."

The payday loan industry varies from state to state in the degree of regulation, auditing practices, examination, bonding and reporting requirements. However, the Federal Trade Commission reminds us that the Truth in Lending Act applies to payday lenders, as it does to other sources of credit. You must receive the finance charge (in dollars) and the APR in writing. If you believe a lender has violated the Truth in Lending Act, file a complaint with the FTC (http://www.ftc.gov/ or 1-877/FTC-HELP).

So, what are the alternatives for people facing sudden debt problems? Consumers Union offers several:

1. Negotiate a payment plan with your creditors. Paying off debts through a payment plan worked out directly with the people you owe (rather than taking on more debt that you can't afford) is the best way to deal with financial problems.
2. Some credit card companies specialize in consumers with financial problems or poor credit histories. Shop around and do not assume that you can't qualify for a credit card. You might be able to get a secured credit card tied to your savings account so that your credit line is the amount deposited in your account. After successfully using a secured card for about a year, you can usually qualify for a regular (unsecured) credit card.
3. Many employers (though probably not school employers) will grant paycheck advances to employees. Because this is a true advance, not a loan, there is no interest accruing.
4. Don't forget about your credit union. Small, short-term loans at competitive rates are one of the things credit unions specialize in.
5. Payday lenders claim that their rates are better than paying "bounced check" charges, but a better alternative is to prevent bounced check fees in the first place. Inquire at your bank about a checking account with overdraft protection.

There are other insidious, potentially dangerous loans out there. They include:

Car Title loans where the value of your vehicle determines how much you can borrow. You keep the vehicle, drive it, maintain it as normal. However, the lender takes possession of the title as security for repayment of the loan.

Miss even a single payment and a guy who looks like a dropout from the Sopranos  comes and repossesses your car, sells it and pockets whatever money he gets for it.

Home Equity loans can be a valuable way to finance big projects such as home improvements. But for the economically fragile, they can be a trap. Miss a payment and you could lose your house. Some unscrupulous lenders count on people missing payments so they can evict the owners and sell the property.

I try to keep an eye out for the ways people waste the money that could move them closer to their retirement (or other) goals. I have been intrigued by the payday loan business for some time as one storefront after another popped up in my area. This has to be the granddaddy of all financial rip-offs. Hundreds of percent interest charged on seemingly small amounts adds up over time. It's a deadly spiral once a person gets sucked into the payday revolving door.

Listen, it's your money. Take control of it. Set up an emergency fund to take care of those unforeseen expenses. Pay off credit cards. But if you find yourself stuck between that famous rock and hard place, shop around for credit, negotiate with your creditors and stay away from outlandish loan arrangements that ring up hundreds of percent in APR.