States Imposing Interest-Rate Caps to Rein In Payday Lenders

By CONOR DOUGHERTY
August 9, 2008; Page A3

The spreading subprime-loan debacle has emboldened some state governments to move aggressively against "payday lenders," outfits that offer high-interest-rate loans to cash-strapped borrowers who pledge to repay them when their next check arrives.

Associated Press

A payday loan company in Columbia, Mo.

As subprime mortgages continue to demonstrate the damage to borrowers and the economy when risky loans are made to sometimes unsophisticated consumers, politicians who once steered clear of limiting the availability of credit now find "fair lending" laws that cap interest rates more palatable.

"There is no way [the legislature] would have taken sides" before the subprime crisis, said Jeff Jacobson, a Republican and president pro tempore of the Ohio Senate. "But given all the other problems we're having on the lending front, it sensitized us and made us have to deal with it."

Early this year, Mr. Jacobson voted for legislation that caps interest rates for short-term loans at an annual rate of 28%. The payday lending industry is trying to get the rate cap law repealed before it takes effect Sept. 1. Last month, New Hampshire's governor signed a law that caps payday loans and car-title loans -- which are short-term, high-interest loans that use a car as collateral -- at a 36% rate. Last year, the District of Columbia Council voted to cap interest rates on payday lending, and last month Sen. Richard Durbin (D., Ill.) introduced legislation that would cap all interest rates for consumer credit at 36% annually.

Across the country, various bills to legalize other forms of high-cost lending have stalled, said Uriah King, a policy associate at the Center for Responsible Lending, a nonprofit research organization. "We used to see all kinds of legislative vehicles to legalize high-cost lending across the country," he said. "Now they're not even being introduced, and if they are, they're not getting hearings."

Among high-interest loans, few have been more roundly criticized than payday loans. These are small loans, usually between $300 and $400, that carry interest rates up to several hundred percent a year and are tied to the borrower's coming paycheck. To get the loan, borrowers write a check postdated to their next pay period.

Payday lenders say they provide a valuable service by assisting borrowers in a pinch, sometimes helping them avoid penalties such as late payments. They also argue that the annual percentage rates are misleading because many of their customers pay off their loans within two weeks.

"State legislators are really frustrated that they can't do anything about the subprime-mortgage stuff," said Steven Schlein, a spokesman for the Community Financial Services Association of America, a trade group representing payday lenders. Mr. Schlein said legislators are going after payday lenders because "it gives them something to say that they're doing something about lenders, even though it has nothing to do with the housing crisis."

Opponents of the loans say lenders profit from a brutal cycle in which borrowers get new loans to pay off old ones, racking up fees and interest payments that can exceed the value of the original loan by several times.

Mitchell Kent, a building maintenance technician in Columbus, Ohio, used payday loans on and off for about seven years, often taking out several at a time, extending the loans and racking up loan totals as high as $1,500. On a few occasions Mr. Kent said, he took out so many loans that his checks to the payday lenders started bouncing, leading to more fees. Mr. Kent took out his last payday loan about two years ago, he said, after calling up his utility company and auto lender to see if he could work out a payment plan. "I just hit rock bottom. I realized I'm not even getting a paycheck anymore," he said.

Many states once had usury laws that prohibited the kind of ultra-high interest rates charged by payday lenders. But during the past decade, many have granted exemptions to payday lenders, allowing them to charge higher interest rates. The industry expanded its reach, and by the mid-2000s payday lending companies started going public for the first time. In 2007, the payday lending industry generated about $8.6 billion in revenue on $50.7 billion in loans, according to Stephens Inc., a Little Rock, Ark., brokerage.

In the past few years, the pendulum has started swinging back. Four years ago, Georgia, where payday lending was already illegal, made it a felony; the industry sued but ultimately lost on appeal. In North Carolina, the practice became illegal in 2005. During the past five years, a handful of states, including New Hampshire, Oregon and Ohio, have taken steps to curb interest rates.

The states' crackdown has given some investors in the industry jitters. "In many people's opinion, regulation is the single biggest risk for payday lenders," said John Hecht, an analyst at JMP Securities in San Francisco.

Consumer advocates say that after years of fighting, their arguments against payday lending are starting to get some traction, partly because of the havoc wreaked by the subprime-mortgage crisis.

"The attitude [in the past] was access to credit is a good thing, and more of a good thing is a better thing," said Mr. King of the Center for Responsible Lending. "There is no way around it: The subprime foreclosure crisis has been a contributing factor to states capping payday loans."

The payday lending industry says new interest-rate limits amount to a de facto ban on payday loans. For a two-week loan, the industry typically charges $15 in interest for every $100 lent. The 36% rate cap advocated by the Center for Responsible Lending reduces the interest payment to around $1.38 every two weeks.

Indeed, payday lenders have withered away in several states that have passed rate caps. Since the Oregon legislature passed a 36% payday loan cap last year, about three-quarters of the state's 330 or so payday lenders have closed.