Rolling over borrowers: preventing excessive refinancing and other necessary changes in the payday loan industry.

• Author: Thomas, Richard J.

INTRODUCTION

In 1993, W. Allan Jones began making small, short-term loans in exchange for a postdated check written for the combined value of the loan and a service fee. (1) This practice had not been seen for over half a century, when "salary lenders" provided short-term loans for small sums in exchange for a future paycheck. (2) In 1999, just six years after Mr. Jones resurrected the deferred payment industry, commonly known as the payday loan industry, payday lenders issued about $8 billion worth of payday loans. (3) In 2004, the industry made $50 billion in loans, (4) a staggering 525% increase in just five years. That same year, it was estimated that the industry charged $3.4 billion a year in fees, such as interest and finance charges, to payday loan borrowers. (5)

The attractive growth potential offered by the payday loan industry has caused an explosion in the number of payday loan stores around the nation; their number doubled between the years 2000 and 2003 and stood, in 2005, at 22,000. (6) To put this growth in perspective, there are more payday loan stores in the state of California than there are McDonald's and Burger King restaurants combined. (7) Despite this rapid expansion, and the subsequent increase in competition among payday loan lenders, the fees charged to borrowers for receiving payday loans have not decreased, as would be expected; since 1993, most fees have remained at the maximum allowed by law. (8)

The dramatic growth of the payday loan industry and the failure of the market to self-regulate payday loan fees have caused concern for many consumer protection advocates, who call for the reform of a system that they claim takes advantage of poor and uneducated borrowers, often forcing these borrowers to refinance when unable to repay their loans. (9) Payday loan critics also complain that many lenders have aggressive, unfair collection practices. (10) Although payday loan critics have proposed several types of reform, most, if not all, have recommended the imposition of usury laws--laws restricting the amount of interest a lender can charge--to prevent payday lenders from taking advantage of borrowers. (11) The imposition of usury law on the payday loan industry presents two concerns. First, loopholes in federal legislation have historically prevented successful enforcement of usury laws against payday lenders. (12) Second, assuming these loopholes could be closed, the enforcement of strict usury laws against payday lenders could, by making payday lending unprofitable, eliminate the industry. (13) If the goal of a state with payday lending problems is to eliminate the industry, then usury laws would be an effective tool for doing so. (14)

If, however, the aim of the state is not to end payday lending, but rather to ensure that borrowers are treated fairly by lenders, then the use of usury laws is not the ideal approach. Instead, payday loan reform should create a situation that is acceptable for both lenders and borrowers. The best way to protect borrowers, while still allowing payday lenders the freedom to issue consensual loans, is to change the way payday lending operates. Four adjustments in payday lending are necessary to enable this balance: (1) ensuring that borrowers are informed; (2) limiting loan refinancing; (3) guaranteeing that fair collection practices are followed; and (4) improving enforcement of the law.

This Note will analyze the problems associated with payday lending in four parts. First, a discussion of the demographics of payday loan borrowers will show that payday loans are often targeted at borrowers who tend to be less educated and economically disadvantaged. Second, a detailed description of how the payday loan industry works will point to refinancing as the most serious problem afflicting payday loan borrowers. Third, analysis of usury laws in connection with payday lending will reveal the flaws inherent in a solution that seeks only to restrict interest rates. Finally, this Note will propose a solution that effectively regulates the industry, without the disadvantages of strict usury laws.

1. PAYDAY LOAN BORROWER DEMOGRAPHICS

   One of the reasons most frequently offered to justify regulation of the payday loan industry is that it preys on minorities, women, and those who are poor or uneducated. (15) Statistics supplied by the payday loan industry refute this claim; however, those supplied by various state agencies appear to support it. (16)

   Most of the industry's statistics are derived from a survey conducted by the Credit Research Center at Georgetown University. (17) According to the survey, about half of payday loan borrowers have an average annual income between $25,000 and $50,000. (18) The survey also indicated that almost ninety-four percent of borrowers have a high school diploma, and that more than half have completed at least some college. (19)

   On their face, these findings lend support to payday loan industry claims that payday lending does not take advantage of poor and uneducated borrowers; however, the survey has serious flaws that cast doubt on its results. First, the findings are based on a very small sample size. The study began with a pool of 5364 payday loan borrowers, randomly selected from payday loan offices nationwide. (20) Survey takers then attempted to conduct interviews with the selected borrowers by placing telephone calls to their residences. (21) An amazing 1274 borrowers, or about twenty-four percent of the initial pool, could not be reached because their phone numbers were invalid. (22) Another 1894 borrowers, an additional thirty-five percent of the initial pool, were not available during the interview period. (23) Survey takers made contact with only about half the initial pool, or 2196 borrowers. (24) Of those borrowers actually contacted, 1584, or seventy-two percent, either denied having received a payday loan or refused to be interviewed. (25) The final sample from which the study drew its conclusions consisted of only 427 borrowers, or eight percent of the total sample. (26) That the initial sample of 5364 borrowers itself was only a small sample of the total number of borrowers who use the country's more than 10,000 payday loan offices (27) emphasizes how small the final sample of 427 borrowers really was.

   The small sample size raises serious concerns about the accuracy of the study's conclusion because it is likely that the sample was not an accurate representation of the average payday loan borrower. (28) Furthermore, the authors of the study acknowledged that most respondents who quit the interview did so after the first few questions asked about the type of credit the respondents had previously used. (29) Those who refused to admit they had used a payday loan "were unwilling to answer financial questions and answered 'no' to avoid further questions of this nature." (30) This finding is important because those with the greatest financial difficulties would probably be the most reluctant to participate in an interview because of embarrassment or fear. Also, some of the most impoverished borrowers might not have had access to a telephone, or might have been working longer or more irregular hours, making it less likely that they could have been reached for an interview. All these factors provide reason to believe that those borrowers who did participate in the interview were better off financially than the average borrower. (31)

   The second flaw with the study is that the authors interviewed borrowers who had taken out a loan during the six months leading up to and through the holiday season. (32) From October to January, even individuals making $50,000 a year might be in need of extra holiday cash and need to take advantage of a payday loan to make up the difference. Some borrowers may have taken out loans in advance of an expected Christmas bonus, knowing the bonus would arrive in time for the payday loan to be paid in full when due. The survey easily could have avoided this potential problem by drawing from an initial pool of borrowers who had taken out a loan between January and December.

   The final potential problem with the survey is that it was financed in part by the Community Financial Services Association of America, one of the trade associations of the payday loan industry. (33) In fact, Association members provided the names of borrowers for the study. (34) The Association's involvement casts suspicion on whether the study was conducted in a manner that would lead to results favorable to the industry, whether intentionally or unintentionally. (35) This suspicion is only bolstered by the fact that the Government Accountability Office (formerly the General Accounting Office) has criticized the Credit Research Center in the past for making assumptions in favor of the lending industry. (36)

   Studies and surveys organized by state-funded organizations have painted a much bleaker picture of the payday loan industry. One Colorado study, for example, found that "[t]he 'average' Colorado payday loan borrower is a thirty-six-year-old single woman, making $2370 per month, employed as a laborer or office worker and in her current job for about three and one-half years." (37) A 1999 survey by the Illinois Department of Financial Institutions found that the average payday loan borrower's salary was just over $25,000, (38) while the average income for the citizens of the state as a whole was over $31,000. (39) In Wisconsin, the average borrower's gross income in 2001 was only $24,673, (40) whereas the average gross income of Wisconsin citizens that year was almost $32,000. (41)

   Statistics like these have led opponents of the payday loan industry to conclude that payday loan lenders specifically target minorities and low-income individuals. (42) A study conducted for the American Association of Retired Persons found that low-income and minority households were more likely to have a payday loan store within a...