Payday loans move up economic ladder

More middle-class consumers facing 'day of reckoning'

Payday lenders, long derided by consumer advocates because of their high interest rates, are proliferating in suburban areas. (Lori Shepler/Los Angeles Times)

CLEVELAND, Tenn. - With its quaint downtown and tree-lined streets, this little city in the foothills of the Smokies seems an unlikely epicenter for a $50 billion-a-year financial industry.

But this is where W. Allan Jones founded Check Into Cash, the granddaddy of modern payday lenders, which cater to millions of financially strapped working people with short-term loans at annualized interest rates of 459 percent.

In years past, a worker might have asked his employer for an advance. Now, with a driver's license, a pay stub, and a checking account, he can walk into a typical payday loan store, postdate a check for $300, and stroll out with $255 in cash after a $45 fee.

No muss, no fuss, no credit check.

And for some, no hope of paying it back any time soon.

Americans pay as much as $8 billion a year to borrow at least $50 billion from payday lenders. That's more than 10 times the level of a decade ago, according to a report by the California Department of Corporations.

Nationwide, the number of payday outlets has exploded from zero in 1990 to some 25,000 today, running the gamut from mom-and-pop outfits to national chains.

Advocacy groups have long bashed payday loans as "debt traps," accusing lenders of baiting customers with easy cash and hooking them into an endless cycle of borrowing.

But as the economy has worsened, payday loans have increasingly become crutches for those higher up the economic scale, said Elizabeth Warren, a Harvard law professor who serves as chairwoman of a congressional watchdog panel on the $700 billion bailout for the US financial system.

More middle-class families use the loans "to put off the day of reckoning," she said. "Too many families live with no cushion, so when something goes wrong, they turn to payday lenders."

As an alternative to payday lending, credit unions and other lenders have begun offering short-term, small-dollar loans at annual rates as low as 12 percent. But many borrowers are unaware of such options.

Although industry statistics show that many borrowers repay on time, others do not. Instead, they borrow from a second lender to pay off the first, or repeatedly roll over or "flip" their loans into new ones, sinking deeper in debt.

The Center for Responsible Lending, a nonprofit and nonpartisan advocacy group based in North Carolina, contends that the average payday loan is flipped eight times, pushing the cost of a $325 cash advance to $793.

"Consumer groups are very effective at using that 3 (percent) or 4 percent of horror stories about people who misused the product and got more loans than they can afford," said Steven Schlein, a spokesman for the Community Financial Services Association of America, a trade group.

Many payday borrowers make $25,000 to $50,000 a year, and many loan stores that don't offer check-cashing or pawn services are in middle-class neighborhoods, he said.

In California, the maximum loan amount is $300, which yields borrowers $255 after a fee of $15 per $100. That's 17.6 percent of the amount borrowed, so if a customer takes a year to pay it off, the annual rate works out to 459 percent - 17.6 percent multiplied by 26 two-week periods

Lenders say it's unfair to express their fees as percentage rates because their loans are short-term. Some liken cash advances to taxi rides, saying that both are bad choices for the long haul - and that borrowers know it.

"We are dealing with people who are a whole lot smarter than what the consumer groups say they are," Jones said.

Modern payday lending's roots reach to illegal "salary buying" of a century ago, when loan sharks charged workers up to 300 percent for cash advances on their paychecks. That led to government regulation of small loans, which eventually were made by finance companies and other traditional lenders. But as mainstream lenders abandoned the market, fledgling payday lenders stepped in - and quickly multiplied.

Still, payday lenders' profits are only slightly higher than those of banks and other financial institutions, according to a December 2007 study by Vanderbilt University Law School and the University of Oxford.

The study noted that while such lenders' interest rates can be astronomical, they also have higher costs because of defaults.

Jones said his company - which has 1,270 outlets in more than 30 states - makes $1.12 on the $15 fee it charges on a $100 loan, after labor, overhead, and other costs.

His major competitors include privately held Ace Cash Express, based in Irving, Texas, and at least five large publicly traded lenders, led by Advance America Cash Advance of Spartanburg, S.C., with some 2,850 branches.

Advance America was founded by George D. Johnson Jr., a developer and former Blockbuster Entertainment executive, and William Webster IV, a Fulbright scholar who hit big with Bojangles fried-chicken franchises and later worked for President Clinton.

After leaving government service in 1995, Webster turned for ideas to Johnson, now 66, whom he'd met through the restaurant business.

"George said, 'Something just came across my desk. Why don't we go look at it?' " recalled Webster, 51, who once worked for a payday lender.

Payday lenders have flourished in part by persuading state lawmakers to exempt them from usury limits and small-loan rate caps of 24 percent to 48 percent for banks and other financial institutions.

But recently, "The pendulum has swung a little more toward the side of the consumer action groups," said Daniel O'Sullivan, an analyst with Utendahl Capital Partners in New York.

But he's not ready to count out the industry just yet.

"At the end of the day, there is a need for the product," O'Sullivan said. "So it comes down to finding something that makes sense for everybody - something the companies can make money at without putting people into a debt spiral."