Short-term lenders may face new regulatory obstacles
Without a pawnshop and a gold onyx ring, Patrick Heinaman's grandmother might have missed her daughter's funeral.
The short-term loan put the 412-mile trip to Port Lavaca within reach. It was costly, but her only option. But Heinaman's grandmother and other low-income borrowers would have a harder time getting an emergency loan of that type if the legislation Congress is considering to cap interest rates on all consumer credit transactions passes.
Both critics and supporters of the bills agree the popularity of payday lenders and other short-term creditors highlight the need for credit among the country's poor and their inability to obtain loans traditionally.
Two bills, one from Sen. Dick Durbin (D-IL), the other from Rep. Jackie Speier (D-CA), would cap interest rates on the loans at 36 percent. The legislation is aimed at payday lenders, but pawnshops and other short-term lenders say the cap would also keep them from making a profit.
"The way I see it, they help families that need the money," the 19-year-old Heinaman said shortly after paying $50 off the balance of his grandmother's loan at Danny's Pawn and Sporting Goods in McAllen. "(Shutting them down), that's like taking meals away from the family."
Critics of the legislation argue that payday lending and pawnshops are the rational choice for low-income borrowers for short-term credit because other options are far more expensive. When bank overdraft fees or penalties for overdrawing a credit card are expressed as annualized interest, the rate can exceed 1,000 percent.
Danny's is one of a few family-owned pawn shops left in the Rio Grande Valley, and owner Danny Gallegos said that if rates are capped he won't be able to pass the store along to his sons when he retires.
While Gallegos said the pawn industry is much maligned as a repository of stolen goods, he argued that he is one of a few providers of credit for poor families who need money to put food on the table, to pay for the yearly migration to farms in the North, and to keep the lights on.
Recently, the pawn business has soared while his retail sales have soured. Consequently, with the roughshod economy wrecking pocketbooks, the store's shelves are crowded.
"We provide a service to low-income, middle-income, and now even high-income people," he said, adding that 80 percent of pawn loans are repaid and the collateral returned. "Honestly, they should raise the rates so that we can lend more money."
The pawn business is already heavily regulated, Gallegos said. The highest rate he can charge on a loan is an annualized 240 percent, a ceiling set by the Texas Office of Consumer Credit Commissioner.
A federal cap would trump state regulation, said Tim Miller, a spokesman for the Center for Consumer Freedom, a nonprofit organization that opposes the legislation.
"The rates that they're capped at are at such a low level that these short-term lenders can't stay viable," Miller said. "Once you eliminate those options that create problems for borrowers, they are only left with more expensive options."
A VICIOUS CYCLE
Supporters of the measures say the legislation is aimed at regulating the freewheeling payday loan industry, which they argue reaps huge profits preying on poor Americans with unscrupulous lending tactics.
Liliana Renteria is director of the San Benito-based South Texas Adult Resource and Training Center, a nonprofit community development corporation that teaches financial literacy and provides other educational services. She has seen several Valley families succumb to vast debt after taking out payday loans, she said.
Payday loans are small, short-term loans. Essentially, they are cash advances on the borrower's next paycheck, obtained when a borrower pays a fee and writes a postdated check for his next payday. Borrowers are required to have a steady source of income, an active checking account and a working telephone number.
If the borrower cannot pay off the loan when it is due -- usually within two weeks -- the loan renews for additional fees and the interest continues to compound. It is a cycle that critics of the industry say traps too many poor people.
"Just giving them one pay period to come up with the money is not enough," Renteria said, adding that borrowers often turn to family members and friends to help pay off the lenders. "The profit these companies are making is enough and they don't need to be taking advantage of the people."
On a recent day, a middle-aged, smartly dressed woman set a rifle down on the counter at Danny's, hoping to sell it for close to $1,000. The woman, who asked not to be identified, said her husband had been out of work sick for nine months and that the family needed the money to pay off a payday loan.
She refused the store's offer, but she is concerned because the fees on her loan continue to mount. For a typical two-week payday loan, there is a $15 charge for every $100 borrowed, which amounts to an annual percentage rate of about 390 percent.
Every time the woman renews, she pays additional fees that add to the effective interest.
The payday loan industry has boomed since emerging in the 1990s, when traditional lenders withdrew from the small-loan market. In 1990, there were almost no locations; now, there are close to 22,000 that lend more than $40 billion a year, according to the Community Financial Services Association of America, the industry's trade group.
It's a good business, too, with lenders averaging about a 10 percent profit margin, said David Burtzlaff, a research analyst who follows the industry at Stephens Inc. and is opposed to the legislation.
"That doesn't sound egregious to me," Burtzlaff said.
Congress has moved before to impose caps on the industry, and 15 states either prohibit the lending or impose their own interest rate caps. In 2006, Congress imposed a 36 percent interest rate cap on loans to military personnel.
Supporters of the legislation say state regulation does not go far enough and that payday lenders often find ways around state usury interest caps.
In Texas, supporters of the proposed federal cap say payday lenders operate with too much impunity as what are referred to as credit service organizations.
As such, they are not required to disclose their loan volume -- the dollar amount or number of loans committed. Nor are the lenders required to advertise how consumers can file complaints, as the state requires other, traditional lenders to do, said Don Baylor, a policy analyst with the Center for Public Policy Priorities, a liberal think tank.
When the Texas Credit Services Organization Act was passed in 1987, it was an attempt to regulate the credit repair business. Legislators did not anticipate how payday lenders would emerge and use the provision in the act that allows CSOs to make loans as an avenue to incorporate in the state, Baylor said.
"Having that kind of loophole undermines other parts of the finance world," Baylor said. "Why are they so special? ... Just like farmers and plumbers (are subject to regulation), they need to have someone to look after their activity."
Two bills circulating in the Texas House and Senate seek to close that loophole and require payday lenders to register with the Texas Office of Consumer Credit Commissioner, as pawnshops are already required to do. But the bills also leave open the possibility of an interest rate cap by giving the office the power to set interest rates.
The payday lending industry is opposed to the legislation. Its members point to industry guidelines for best practices -- which include a mandatory, free extension for borrowers unable to pay after the first period of their loan -- as evidence that they do not need more regulation.
Dozens of the Valley's payday lending locations refused to comment for this story. Almost all of them are owned by large corporations and said it was company policy to refer reporters to corporate executives for comment. Some payday lenders did not return calls for this story.
One manager at a downtown McAllen location -- where payday lenders thrive -had printed out fliers he passed out to customers to urge them to contact their lawmakers and ask them to vote against the legislation.
He's worried about losing his job and he said many smaller payday lenders are completely unaware the industry could soon die.
"It's kind of hard to find a job right now," he said.
Corinna Spencer-Scheurich, an attorney with the South Texas Civil Rights Project, acknowledged there would be a huge void in lenders for low-income borrowers if the bills pass.
However, she argued more regulation is long overdue for payday lenders. If it is so profitable, she said, other lenders would step up to fill the void if the payday lending industry does go away -- something she's not sure will happen.
"People shouldn't be using this product, because it puts them in a cycle of poverty," she said.
Still, she cautioned, "we really need to start working to provide alternatives."
At Danny's Pawn and Sporting Goods last week, Armando Quintanilla rifled through a bin of cassette tapes, picking up hair metal and arena rock music from the 1980s. He described how he routinely pawns his family's possessions to pay bills and for the occasional beer or a movie.
The 45-year-old caretaker works full-time attending to his 94-year-old, bedridden mother-in-law. His sister-in-law pays him a salary. He has nothing pawned now, but his wife owes $45 to recoup a television she exchanged for a cash loan. He has regained every item that he has put up as collateral for a pawn loan, he added.
He said it is not the government's role to decide what is best for him and allow pawn shops to fall victim to legislation designed to curb payday lenders.
"I wouldn't do it if I didn't need it," he said "I had to pay the water bill or I will get disconnected."
Reprinted from our sister site, FinReg21.com