Published: April 2010

Online payday loans trap borrowers

New loans skyrocket when consumers can't pay back the first loan

Coalition: Financial Reform

This joint letter to Congress signed by leading consumer advocacy groups explains the harm from online payday loans, a growing avenue for high priced payday lending. Since the online lender has electronic access to the borrower’s bank account, these loans are first in line to be repaid ahead of food, rent, or other necessities when these triple-digit loans are made to struggling families.

We, the undersigned consumer and community organizations, are writing to alert you to the dangers of online payday lending and to urge you to support a strong independent Consumer Financial Protection Agency to protect consumers from predatory online lending.  An industry trade group representing payday lenders who use the Internet to deliver and collect triple-digit interest rate loans will be in Washington this week promoting a predatory loan product that only leaves already struggling consumers even worse off.

Payday loans are small loans secured by direct access to the borrower’s bank account.  Under the traditional storefront model, borrowers give lenders a post-dated check, which the lender deposits on the borrower’s next payday.  Payday loans are marketed as short-term, but the terms are difficult to meet and the industry depends on revenue from people caught in a cycle of long-term debt for their survival.  Over 90 percent of payday lending revenue comes from borrowers who take out five or more loans per year. Over 75 percent of all loans are caused by “churn,” the inability of borrowers to successfully repay without taking out a new loan.

While the terms of online lenders are just as bad as storefront loans, the mechanism by which the loans are repaid can leave consumers even more vulnerable to the lenders. Typically, the loans are structured as single-payment loans to exploit legal loopholes that would otherwise give consumers the right to stop payment and that prohibit conditioning credit on electronic access to the consumer’s bank account.  Yet the loans in operation can result in multiple charges to the consumer’s account.  Since the online lender has electronic access to the borrower’s bank account, these loans are first in line to be repaid ahead of food, rent, or other necessities when these triple-digit loans are made to struggling families.  Some lenders insert language into the online agreement allowing them to use consumers’ bank account information to create an unsigned paper check to continue collections, even when consumers attempt to exercise the rights conferred by the Electronic Fund Transfer Act for consumers to withdraw authorization that allows lenders to access the account electronically.

Online payday lenders use electronic funds transfer to collect payment from borrowers’ bank accounts by withdrawing Social Security, SSI, veterans’ benefits and federal pensions.  These funds are exempt from attachment by creditors but payday lenders evade that federal protection by structuring loans to withdraw funds as soon as they are direct deposited into recipients’ accounts.

Online payday lending began in large part as a way to avoid state regulations of payday lending.  The online industry has grown in recent years, with estimated loan volume of $7.1 billion.  Estimates based on available public data indicate that online payday loans cost 400 percent to 780 percent APR and are often structured to automatically renew, with lenders withdrawing the finance charge every payday without paying down the loan for several cycles.  The average fee is $25 per $100 loaned, or 652 percent APR for a two week loan.  A $500 online loan can cost $125 every payday without any reduction in the loan principal.

Congress and the Department of Defense put online payday lenders off-limits to active duty Service members in 2007.  The John Warner Defense Authorization Act of 2007 banned loans based on unfunded checks or electronic access to Service members’ bank accounts and capped the cost of covered credit at 36 percent including interest and fees.  As a result, online and storefront payday lending to covered Service members and their families is illegal.
A significant concern is that online payday lenders often operate in violation of state laws prohibiting payday lending or capping interest rates.  State Attorneys General and credit regulators across the country are fighting an uphill battle to enforce state credit laws and usury caps against online payday lenders.  The Federal Trade Commission recently charged online lenders in Utah with illegally trying to garnish borrowers’ wages and using other illegal debt-collection practices.  The same lenders were ordered to desist from unlicensed lending by California regulators.  The West Virginia Attorney General has brought almost a hundred cases against online lenders and debt collectors that ignored West Virginia’s small loan rate cap.  The Attorney General of Arkansas filed a complaint in January against Geneva-Roth Capital, Inc. and Geneva-Roth Ventures, Inc. d/b/a LoanPointUSA.com and CEO Mark Curry for making loans that cost up to 1,365 percent APR in violation of Arkansas’ constitutional usury cap.

Online payday lenders use a variety of devices to evade state consumer protections.  Regulators in California and Colorado are litigating cases involving online lenders that claim tribal immunity from state laws.  After the Online Lenders Alliance challenged a regulatory ruling in Minnesota, legislation was enacted to clarify that state credit laws apply to online lenders.  The Minnesota Attorney General recently filed charges against three online payday lenders for ignoring Minnesota’s payday loan law.  The Pennsylvania Banking Commissioner won a court challenge to a regulatory ruling brought by Cash America’s CashNetUSA.   A Maryland bill is awaiting signature by the Governor to stop online payday lenders from claiming to be credit services organizations to evade that state’s small loan laws.

While the online payday lending industry highlights their financial literacy program and their “best practices,” neither of these public relations programs makes online payday loans safe for borrowers or good policy for the credit market.  Academic research demonstrates that payday lending is harmful to borrowers, doubling the risk of being seriously delinquent on credit card payments.  Using payday loans also increases the risk a borrower will end up in bankruptcy within two years and makes it less likely that consumers can pay other bills or get healthcare.  Payday loan use also increases the likelihood that consumers’ bank accounts will be closed involuntarily.

We strongly urge your support for a strong Consumer Financial Protection Agency as part of financial regulatory reform.  We need an independent agency to rein in abusive loan products such as triple-digit interest rate online payday loans that trap borrowers in debit and hi-jack consumers’ bank accounts.  The agency needs both rule-writing and enforcement authority.  These rules should be a floor of consumer protection, allowing states to stop a local problem from becoming a national crisis.

We urge you to oppose any legislation to authorize online payday lending at triple-digit interest rates and to preempt more protective state laws.  Bills introduced by Representative Baca (H.R. 1846) and Representative Schuler (H.R. 2563) undermine protections provided by the Electronic Fund Transfer Act and authorize payday lenders to create unsigned paper checks to withdraw funds from consumers’ bank accounts even when those consumers exercise their rights to revoke authorization to electronically withdraw funds.  The Schuler and Baca bills authorize online lenders to charge 520 percent APR for a two-week loan, plus additional fees for new loans in H.R. 2563 that make a $100 two-week loan cost 910 percent APR.  Both bills preempt state laws that are more protective for consumers.

Lead Organization

Consumer Federation of America

Other Organizations

Consumers Union | US Public Interest Research Group | Center for Responsible Lending | Consumer Action | National Consumer Law Center (on behalf of its low income clients)

More Information

Jean Ann Fox, Consumer Federation of America

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