More comments on payday loans and check cashing facilities

The Bible forbids usury. In the days of ancient Israel, "usury" meant lending money at any interest. God commanded the Hebrews to lend to one another at no interest.

Obviously, we've come to realize that money has a time value - $1,000 today is more valuable than $1,000 in one year's time. Lenders should be compensated for lending. However, credit is essential to business and may be required to regulate a household's cash flow. All people should have access to an appropriate amount of credit at a reasonable rate.

I do not think payday lenders charge a reasonable rate for their services. Check cashing facilities, which serve the unbanked and give people their checks in cash, also do not charge a reasonable rate. I realize a number of people commented on my last post about payday loans, saying that they're not all bad.

If one uses these alternative services judiciously, they're fine. The problem is that payday loans have been known to use predatory lending practices. An MSN Money article maintains that payday lenders have conspired to "ambush" military families:

And payday lenders make a point of targeting people in the military. Why? Because they know military personnel have steady paychecks, are unlikely to get laid off or quit their jobs and -- given that many personnel are young and away from home for the first time -- often have little in savings and not much experience in managing personal finances.

Plus, military personnel tend not to be highly paid. That makes it likelier they'll need to get their hands on cash in a hurry.

Payday loan and check-cashing shops are concentrated around military bases, and online lenders aim their products at military personnel, using ads that trumpet "military loans" and "exclusively serving the military." The Department of Defense estimates that one in every four military service members has taken out a payday loan.

Not only is this a problem for the people who find themselves entering a debt spiral, but service members with low credit scores or too-high debt loads may find their financial problems affect their security clearances. Ultimately, that can mean service members are unable to deploy when needed.

It's easy to see the appeal of payday loans: Lenders promise same-day cash and an easy repayment plan, and they often don't make clear how much borrowers will end up paying in interest. For someone who needs cash fast, especially in these tough economic times, the offer may be hard to resist.

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But the real problem is that borrowers can fall into a cycle of debt: If their paychecks don't cover their first loans, they may take out new loans to pay off the initial ones. Nine out of 10 service members who take out a payday loan wind up taking at least five loans a year. By the time you've rolled over your debt several times, the interest rate on that original loan has ballooned out of control. The average borrower pays $834 for a $339 loan, according to a 2006 U.S. Department of Defense report (.pdf file) on payday lenders.

Payday lenders don't limit their depredations to military families, either.

Then again, mainstream financial organizations don't offer services that are appropriate to all customers. If done properly, payday-type loans and check cashing services can be appropriate. A recent NY Times article profiled a check cashing service which had been bought by a credit union.

There are two big problems with businesses like Nix Check Cashing. One is that the fees are high. Most cashers pocket between 2 and 4 percent of each check’s value, which a recent Brookings Institution study calculated could add up to $40,000 in fees over a customer’s working life. And their version of credit, a two- or four-week cash advance against a postdated check, known as a payday loan, is even pricier — about 30 times the annualized interest rate of a typical credit card.

The second problem is that cashing your paycheck, instead of depositing it, encourages you to spend all your money rather than saving whatever is left over at the end of the month. (Down the counter, a pair of young black women in tight, bright tops looked around a bit nervously as a cashier counted out thousands in small bills. “It’s tax-refund time,” the cashier told me as the women walked out.)

But it’s also true that traditional banks are far from blameless, especially where low-income customers are concerned, and check cashers and payday lenders do get some important things right. “If they’re properly regulated and scrutinized, there’s nothing wrong with check cashing as a concept and there’s nothing wrong with payday loans as a concept,” Robert L. Gnaizda, general counsel for the Greenlining Institute, a California nonprofit focused on financial services and civil rights, told me. “And there’s nothing automatically good about free checking accounts if you have multiple fees whenever you make the most minor mistake.”

Today’s financial crisis has many origins. But here’s one cause that is often overlooked: Traditional bankers badly misread the market for financial services in low-to-moderate-income communities. “Banks have been approaching these customers purely from a short-term-gain perspective, and they’ve missed opportunities,” Matt Fellowes, director of the Pew Safe Banking Opportunities Project, told me. Banks declined to offer small, simple lines of credit to poor and blue-collar customers, leaving them to payday lenders, while they pushed high-limit, high-interest credit cards on everyone and acquired hundreds of billions in subprime debt. They undervalued the hundreds of billions a year in modest paychecks that pass through a place like Nix and ended up short on cash. Now that the economy has turned ugly, these poor and blue-collar customers are the hardest-squeezed. Payday loans are up, Nix told me when I spoke to him recently, and check-cashing revenue is down.

Legislators around the country have identified savings as a way to shore up low-income communities and expand the middle class. There are a few significant bills before Congress, and more at the state level, that would help poor and working-class families save money — like increasing the amount welfare recipients are allowed to sock away before the system cuts off their benefits. But some 28 million Americans still go without a bank account, including more than 20 percent of Latino and African-American households, and more than 50 million have no credit score, which means no access to mainstream credit. These are the people in line at Nix.

The author details some examples of how mainstream financial services don't cut it for everyone:

Bank of America took heat earlier this year for more than doubling the interest rate on some credit-card accounts, even if the cardholder pays every bill on time. Banks, meanwhile, have nearly quadrupled their fee income in the last decade, according to the F.D.I.C., while credit-card late charges and over-limit charges have nearly tripled. Fees imposed on customers for temporarily overdrawing their accounts — by accident or on purpose — have been particularly lucrative; banks made $25.3 billion in 2006 on overdraft-related fees, up 48 percent in two years, according to the Center for Responsible Lending. On the Web site of Strunk and Associates, a big seller of overdraft programs, bank and credit-union executives offer glowing testimonials. “Strunk’s program has exceeded expectations,” one writes. “We have generated a 100 percent increase in overdraft revenue.”

Some customers choose Nix over a bank because it is cheaper than paying overdraft fees. For others, it’s convenient. Some go to Nix because check cashing is what they know. Others go because they live in communities where nobody takes a check or a card, not even the landlord, and cash machines are scarce. Still others go because they always seem to have a Final Notice in the bill stack, and they can’t wait a week or longer for a paycheck to clear — that includes a lot of people with a bank account somewhere.

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Nix’s cashiers also try to never say no. Take photo identification. A lot of customers don’t have a driver’s license. Nix stores have accepted high-school yearbooks. They’ve been known to cash a McDonald’s paycheck if someone comes in wearing a McDonald’s uniform. They even have a phone in the lobby, so a cashier can call a customer’s job site and then patch the customer in, listen to him talk to his supervisor and decide if they sound like a legitimate boss and employee. Nix says he loses as much as 5 percent of his check-cashing revenue on bad checks, but it’s worth it, he says, to be known as a place that says yes.

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There’s a bank, just down the street, that could do those things free. I asked him (Oscar Enriquez, an interviewee) why he didn’t take his business there.

“Oh, man, I won’t work with them no more,” Enriquez explained. “They’re not truthful.”

Two years ago, Enriquez opened his first bank account. “I said I wanted to start a savings account,” he said. He thought the account was free, until he got his first statement. “They were charging me for checks!” he said, still upset about it. “I didn’t want checks. They’re always charging you fees. For a while, I didn’t use the bank at all, they charged like $100 in fees.” Even studying his monthly statements, he couldn’t always figure out why they charged what they charged. Nix is almost certainly more expensive, but it’s also more predictable and transparent, and that was a big deal to Enriquez.

So, I'd like to retract my unconditional opposition to payday lenders.

However, that doesn't change the fact that the industry is filled with predatory lenders. To change my mind, the payday loan industry will need to start taking responsibility.

Nix's business was bought by a credit union that was looking to act responsibly:

In the spring of 2007, Nix was working hard to unload his business. He had actually been trying to sell his chain to a bank for more than a decade, and now he was running out of time. He was about to turn 60, and he thought he owed his family (and his investors) an exit. Nix wanted to sell high to a responsible bank, retire well and be a hero, the guy who took real banking to L.A.’s poorest neighborhoods. But the most likely buyer was another check-cashing chain. Nix was prepared to do the deal, but it was not how he dreamed of going out.

Then Kinecta Federal Credit Union called with its offer. “We were trying to understand why check cashers have been successful in underserved areas where banks haven’t,” Kinecta’s president and C.E.O., Simone Lagomarsino, told me. What they concluded was that most banks simply didn’t know low-income neighborhoods or understand them. “We go in with this cookie-cutter approach: This is our branch, this is our way we do business,” she says.

As Nix and Lagomarsino negotiated the sale, he encouraged her to make it easier for his customers to open a bank account. At most banks, if you’ve bounced too many checks, you’re banned for five to seven years. Lagomarsino agreed to reduce that limbo period to one year. Next she realized she would need to deal with the most controversial part of Nix’s business, the payday loans. At first, she told me, “I assumed we wouldn’t do them.” Nix actually felt the same way, once. In the late 1980s, when a few check cashers started to accept postdated personal checks and advance cash for a fee, Nix thought it was a sleazy scheme. He thought so even after California legalized the practice in 1997. “I didn’t want to be a loan shark,” he told me. “But the reality is, customers wanted it.”

He told Lagomarsino why. A bounced check, a fee to reconnect a utility, a late-payment fee on your credit card, or an underground loan, any of those things can cost more than a payday loan. And then there are overdraft charges. “Banks, credit unions, we’ve been doing payday loans, we just call it something different,” Lagomarsino says. “When it starts to get used like a payday loan, it’s worse.”

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Kinecta’s executives decided to keep the payday loan and change the terms. Starting with three stores in the spring, and eventually across the entire chain, Nix is increasing the maximum loan from $255 to $400. They are dropping the fee from 18 percent ($45 for a two-week $255 loan) to 15 percent ($60 for a two-week $400 loan). And they will rebate a third more ($20, in the case of a $400 loan) into a savings account, after six months, if you pay your loans back and don’t bounce any checks. People get payday loans because they have no savings, Lagomarsino explained. After six months, heavy payday borrowers will accumulate a small balance. Enough, she and Nix say they hope, to convince them they can afford to save more. Later, they say, they intend to drop fees further for borrowers who always pay back on time.

And so, if done right, this can be a viable solution for low-income people. One should also remember that credit cards are a mainstream financial product, and that anyone can open five credit card accounts, pile on a lot of debt, and get into trouble. We don't say credit cards should be outlawed, so I suppose I shouldn't necessarily say all payday services should be banned.

However, to be frank, I would be perfectly happy if the entire industry were closed to for-profits and given to the credit unions - as customer-owned non-profits, they have no direct incentive to screw over their customers - members, actually. The fact remains that the US banned payday lending to military personnel based on reports from their Department of Defense.