Customers of Payday Lenders Can Be Forever in Their Debt

Christmas 2001 haunted Anita Monti for nearly two years.

The 60-year-old North Carolina resident was behind on her electric bill and short of cash to buy presents for her grandchildren that year, so she applied for a short-term “payday” loan.

That mistake locked Monti into a cycle of twice-monthly borrowing that ultimately cost her $1,780 to repay $700 in loans -- thanks to an effective annual interest rate exceeding 400%. Before the matter was resolved, Monti required both credit counseling and a bailout from her church.

Monti’s story is far from unique.

The payday lending industry, virtually nonexistent a decade ago, accounts for roughly $25 billion annually in loans, according to a recent study. More than 90% of payday loans are made to repeat borrowers such as Monti, whose short-term cash crisis was only worsened by the quick fix.

“I hated to see Fridays come because I knew I’d have to go to the bank, pull out all of my money to pay [the payday lender] and then get another loan to pay my bills,” said Monti, a computer assembly technician. “It just got worse and worse.”

Payday loans are deceptively simple short-term deals. The name comes from the fact that they’re essentially a two-week advance designed to tide over the borrower until his or her next payday.

To get a payday loan, the borrower must have a job and a checking account. The borrower shows the lender a pay stub -- to prove he or she has a job and thus will get some cash within two weeks -- and then writes a postdated check to the lender. The check, which is for the amount of the loan plus a fee that usually amounts to 15% of the loan amount, serves as security for the loan.

If the borrower doesn’t return to repay or renew the loan by the date on the check, the check is presented at the borrower’s bank for payment. If the balance in the borrower’s account can’t cover the check, the borrower faces bounced check fees from the bank and the payday lender.

Unfortunately, borrowers who are so strapped for cash that they can’t make it to their next paycheck probably won’t be able to pay off the loan within two weeks, especially after paying the loan fee, said Jean Ann Fox, director of consumer protection for the Consumer Federation of America.

Consequently, most borrowers end up renewing the same loan multiple times. Each time the loan is renewed, the fee must be paid again, she said.

The typical annual effective percentage rates on payday loans range from 391% to 443%, according to a study released last month by the Center for Responsible Lending. Payday lenders get around state usury laws by characterizing the cost as a fee rather than an interest rate.

The study found that 66% of payday borrowers take out five or more payday loans a year and nearly one-third of payday borrowers get 12 or more loans each year.

Critics of payday lending cite such studies as evidence that the practice doesn’t solve a borrower’s short-term cash crunch. To the contrary, said Fox, it often makes the situation worse.

That’s largely what happened to Monti. She first borrowed $300, paying a $45 fee, to catch up on a few bills and buy some gifts for her five grandchildren. But she had car trouble during the week, and the repair bill put her even further behind.

She renewed the loan, paying another $45 fee, and went to a second payday lender to borrow an additional $400 to make the car repairs, paying a $75 fee.

Monti didn’t take out any more loans, but she renewed her existing loans eight times each, paying $1,080 in fees. The mounting cost of the loans eventually made it impossible for Monti to pay her rent.

She sought help from a credit counselor and her church. The church paid her rent; the credit counselor talked the payday lenders into a monthly payment plan -- something payday lenders are usually not willing to do.

In the middle of last year, Monti finally paid off the loans.

Once a borrower gets in the cycle of paying fees, they can’t pull together enough money to pay off the loan, said Rebekah O’Connell, credit counselor with Triangle Family Services in Raleigh, N.C. “The borrowers are trapped,” she said.

A spokesman for the Community Financial Services Assn., which represents the payday lending industry, bristles at the criticism. People who are so strapped financially that they can’t make it to their next paycheck have several options, he said, and none of them are good.

“These are not ignorant consumers,” said Steven Schlein, spokesman for the Washington-based CFSA. The average payday borrower earns $25,000 to $50,000 a year and has at least some college education, he said. “They are choosing this option over the other alternatives.”

In the past, the only alternatives for people with an immediate need for cash would be visiting a pawn broker, getting a cash advance on a credit card, borrowing from relatives or simply bouncing checks -- all options that have risks and costs of their own.

“Is it a desirable outcome that people roll over their loans? No,” Schlein said. “But is it a better option than pawning your wedding ring or using a check that’s going to bounce to pay your heating bill?

“These [consumer protection] groups think they’re doing good, but they are not offering sensible alternatives.”

Consumer Federation’s Fox maintains that some of the old alternatives are more sensible than payday loans.

“A pawn transaction is finite,” she said. “If you pawn your electric guitar and you can’t afford to buy it back, they sell it and it’s over. A payday loan is a debt that keeps causing you problems. It solves your cash crisis for exactly two weeks.”

Getting a cash advance on a credit card also isn’t a great option -- it usually costs more than 20% in annual interest charges. But it’s a loan that can be repaid over time and it’s far less expensive than a payday loan, she added.

Too often, consumers are lured into payday loans with the thought that their cash crunch will be better after the next paycheck, but a growing body of statistical evidence says that’s simply not true, Fox added.

“You have to ask yourself, ‘What’s going to happen when the two weeks are over?’ ” she said. “You haven’t solved the problem, you’ve just postponed it.”

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Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy.kristof @latimes.com. For past Personal Finance columns visit The Times’ website at latimes.com/kristof.