Payday loans mushroom among middle class
CLEVELAND, Tenn. -- With its quaint downtown and tree-lined streets, this little city in the foothills of the Great Smoky Mountains 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.
"It's the craziest business," said Jones, 55, a homegrown tycoon who founded his privately held company in 1993. "Consumers love us, but consumer groups hate us."
In years past, a worker might have asked his employer for an advance on his paycheck. 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.
By various estimates, 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.
In California alone, customers now borrow about $2.5 billion a year from payday lenders, according to the report.
The number of payday outlets nationwide has exploded from zero in 1990 to 25,000 today, running the gamut from mom-and-pop outfits to national chains.
In Pennsylvania, storefront payday lenders mostly have disappeared because of enforcement of a 1930s-era law that limits interest-based fees. State banking regulators now are requiring similar Internet lenders to obtain licenses by Feb. 1 if they want to continue doing business with Pennsylvania residents, but as of last week, none had applied.
"They have three options: Get a license and comply with the requirements, stop making loans here or say 'Catch me if you can,'" state Banking Department spokesman Dan Egan said.
The department will seek out violators, and wants to hear from residents who feel they've been charged more than they should have been for a loan via the Web, Egan said. Pennsylvania law sets varying interest limits, but generally, the aggregate total of fees shouldn't exceed a 27 percent annual percentage rate.
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 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."
Payday loans aren't available only on payday. The term derives from the fact that they are designed to help borrowers get from one paycheck to the next, usually about two weeks.
As an alternative to payday lending, some 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.
"That's common, that's hoped-for, that's expected," said Ginna Green, the center's California communications manager. "These loans are designed to be flipped and refinanced, over and over and over."
Lenders say that Green's organization and others exaggerate borrowers' difficulties.
"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 earn $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.
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.
Jones, widely considered an industry pioneer, got his start here in Cleveland, population 38,000, his hometown.
Two decades earlier, he had dropped out of college to work in his father's credit bureau and collections business. He hit upon the cash-advance idea in 1993 while wooing a job candidate.
"I found him in this old service station and he had a banner up that said, 'Check Cashing,"' Jones said. "When I went in to try to hire him, I had to keep moving out of the way because customers kept coming in and thanking him for being open."
As Jones tells it , grateful borrowers were happy to trade 20 percent of their next paycheck for a two-week advance rather than miss bill payments or face bank fees for bounced checks.
Jones, whose fortune has been pegged at $500 million, owns a gated 600-acre estate in Cleveland that features a lighted football field with spectator stands, a car collection that includes "everything my daddy wouldn't buy me," two corporate jets, a shopping center, office buildings, apartments and restaurants.
A major philanthropist and preservationist, he has doled out millions for civic projects, including a new wrestling facility at Cleveland High School and an aquatics center at the University of Tennessee in Knoxville.
But not even good works can quiet those who decry payday lenders.
"We look at those big pots of money and we know where it came from: low- to moderate-income workers who are writing checks each week without money in the bank," said Jean Ann Fox, the Consumer Federation of America's director of consumer protection.
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 payday lenders' interest rates can be astronomical, they 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 exited Pennsylvania last year, after state banking officials challenged its fees in court.
Advance America was founded by George D. Johnson Jr., a developer and former Blockbuster Entertainment executive, and William "Billy" Webster IV, a Fulbright scholar who hit big with Bojangles fried-chicken franchises and later worked for President Bill 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.
"It was an incredible business," he said. "I had never seen a business that was as quick to fulfill such a compelling consumer demand."
He and Johnson started Advance America in 1997 and took it public in 2004. In 2007, the company made 11.5 million loans to 1.5 million customers, posting $54 million in net income on record revenue of $709 million.
Through the first nine months of 2008, Advance America's revenue decreased 4.7 percent to $501.5 million, and net income fell 24 percent to $32.5 million.
The decline is largely because of legislative efforts to cap interest rates.
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.
In a 2007 study, the nonpartisan National Institute on Money in State Politics found that California was among the top recipients of contributions from payday lenders. State-level candidates and political party committees garnered $837,673 from 1999 to 2006, trailing only Illinois and Florida.
In 2007, Congress put a 36 percent rate limit on loans to members of the armed services, effectively ending cash advances to military families.