Marketed as a way to help consumers pay the bills until their paychecks arrive, payday loans trap consumers in terrible cycles of debt, dragging their families more deeply into financial crisis. In return for a loan, the consumer provides the lender a post-dated check for the amount borrowed plus a fee. The check is held for one to four weeks (usually until the customer’s payday) at which time the customer redeems the check by paying the face amount or allowing the check to be cashed. Payday lenders encourage their customers to get on a debt treadmill by refinancing one payday loan with another. The fees for payday loans are exorbitant with effective interest rates that can top 1,000 percent.
The repeal of usury laws has allowed payday loans and other predatory lending to flourish.
The banking industry is making forays into the high-cost lending market with “bounce protection” plans, a new form of high-cost credit that boosts fee income for banks. Using aggressive marketing techniques, banks are encouraging their low- and moderate-income customers to use bounce loans as a source of credit. Rather than denying a withdrawal, banks permit customers to overdraw at the ATM or through debit card transactions without informing them about the overdraft or accompanying fees.
Used mostly by low and moderate income consumers, tax refund anticipation loans are extremely high-cost bank loans secured by the taxpayer's expected refund -- loans that last 7-14 days until the actual IRS refund repays the loan. Even without the costly loan, most taxpayers could have their refund in two weeks or less. RALs are aggressively marketed by income-tax preparation companies. They advertise "Instant Refunds" or "Quick Cash" for their cash-strapped customers who need money in a hurry, and disguise the fact that they are selling advance loans on anticipated tax refunds.
Usury laws prohibit lenders from charging borrowers excessively high rates of interest on loans. These laws have ancient origins, as usury prohibitions have been part of every major religious tradition. In the United States, every colony adopted a usury statute based on the English model. This trend continued after independence, with state usury laws protecting consumers from abusive lending until the last quarter of the twentieth century. During this period, preemption wiped out usury laws for most banks. In recent years, many states have started restoring protections against high cost lending to the extent permitted by preemption principles. For instance, some states have established caps on the interest rates that finance companies-- which are not banks-- can charge for small dollar loans, such as payday and auto-title products.
In the last several years, banks have been able to ignore state consumer protection laws because those laws have been “preempted” – wiped out – by federal bank regulations and court interpretations of federal laws. Broad preemption of state law is a recent phenomenon. For most of the 150 years since national banks were created, they were expected to comply with state law. Preemption has harmed states’ ability to respond to financial abuses in both the banking and the non-bank world.
The repeal or preemption of usury caps and the deregulation of consumer credit in the last couple of decades has ushered in a new wave of predatory small loans. Annual interest rates of 300% to 1,000% or even higher are often disguised by the structure of the loan. These loans take various forms, including payday loans, overdraft loans, auto title loans, tax refund anticipation loans, and rent-to-own transactions. What they have in common is high costs for those least able to afford them and the propensity to trap consumers in terrible cycles of debt.
Download these brochures from the National Consumer Law Center.