High-cost, short-term advances are being offered to cash-strapped consumers by a growing number of U.S. banks and credit unions, and consumer advocates fear more are on the way. These so-called payday loans are often considered something to avoid because the two-week terms, balloon payments and big fees create effective interest rates that run well into triple digits and contribute to what consumer advocates call a “debt trap.”

Warning

The National Consumer Law Center, a nonprofit advocacy group, issued a warning in August that payday lending was on the rise among major U.S. banks. Cincinnati-based Fifth Third Bank and Regions Financial Corp. in Birmingham, Ala., among the recent entrants to a market that already includes San Francisco-based Wells Fargo and Minneapolis-based U.S. Bancorp, both of which have Inland operations.

Not a new game

Wells Fargo’s Direct Deposit Advance has been around since 1994, offering customers short-term loans of up to $500 for a flat fee of $1.50 for every $20 borrowed. Borrowers must have direct deposit of a paycheck or other means of support to qualify; the loan is repaid automatically when their next check hits the bank. Wells Fargo spokeswoman Richele Messick said the loan “is an expensive form of credit, and it’s not intended to solve longer-term financial needs.”

Real costs hidden

Consumer watchdog groups say the fixed-fee structure hides the real costs of the loan. A 10-day, $400 loan from Wells Fargo, for example, carries a $28 fee. That’s an effective annual interest rate of 274 percent. Rates for other major banks run even higher. Many bank loans have hefty late fees, and because banks have control over customer accounts, payments are automatic, which means customers risk overdraft fees if there isn’t enough left to cover other financial obligations.

Payday loan industry

Greg Larsen, a spokesman for the California Financial Services Providers Association, said the payday loan industry welcomes legitimate, government-regulated competition because it gives consumers more choices in the marketplace and helps prevent them from turning to unregulated online lenders operating overseas. “We believe consumers can make the best financial choices for themselves, knowing their own personal situations,” Larsen said. “The vast majority of payday loan customers use the products responsibly to handle a short-term cash shortfall by paying back their loan on time and moving on.”

A recent report by the Idaho Press made the claim that Idaho is one of the most lenient states when it comes to payday loan laws. While Idaho’s laws are loose, allowing short term borrowing of up to $1,000 with no interest rate cap, Loans.org set out to find whether Idaho truly is the worst in the nation. Only one other state was worse.

Utah

Utah, best known for Bryce Canyon and Zion national parks, brings a new meaning to the word “relaxed” with their payday loan laws. Utah law permits borrowers to take out payday loans of any amount, so long as lenders are willing to fulfill such requests. Theoretically, Utah borrowers can receive a limitless amount of money on a single two-week loan if they can find a willing lender. Compare that with California, which limits short-term financing to $300.

No usury limit

According to Utah’s Department of Financial Institutions, there is no usury limit in Utah. This means lenders can charge whatever rate they deem necessary. In an industry where annual percentage rates (APRs) of 300 percent to 2,000 percent are not uncommon, this is a very dangerous piece of loan anatomy to leave unrestricted.

Concurrent payday loans

Finally, according to Paydayloaninfo.org, a branch of the Consumer Federation of America, there is no limitation on how many concurrent payday loans an individual may take out. Borrowers are free to hop around from lender to lender, taking these cash advances out from each one they pass.

The San Jose City Council voted Tuesday to cap the number of payday lenders that critics liken to loan sharks who trap low-earning workers in a cycle of debt. The council’s 9-1 vote makes San Jose the largest city to limit the number of payday lenders and the first to block them from opening in or near poor areas. The ordinance allows the 39 payday lenders in the city to stay in their current locations.

Not healthy

“We know these loans are not healthy financial decisions,” Councilman Ash Kalra said. “Putting the cap in place certainly helps.” Councilman Pete Constant was opposed and Councilwoman Rose Herrera was absent. The California Financial Service Providers Association, a trade group for payday lenders, argued that the businesses fill a need for consumers to access quick cash and credit. Under the San Jose law, if an existing lender closes, another could replace it at the same location within six months. After that, the new lender would have to be a quarter-mile from any other lender and from low-income areas.

 Quick cash

Payday loans offer a quick source of cash for those who live on a low income. In exchange for a postdated check, they get up to $300 in cash but must promise to repay the loan plus a $45 fee within two weeks.

Two of Arizona’s major national banks offer “advances” on their customers’ direct deposits that are similar to payday loans, consumer advocates say. A study by the Center for Responsible Lending concluded that the typical annual percentage rate charged on these “bank payday loans” is 365 percent. Another Arizona lender, CheckSmart stores, is offering lines of credit and overdraft protection to purchasers of prepaid debit cards. Those relatively complicated loans charge fees and interest that can add up to an annual interest rate of about 400 percent. Finally, a company called Cash 1 LLC agreed last month, after being sued by the Arizona Attorney General’s Office, to stop selling gift cards to large retailers with a credit option that charged a typical annual rate of about 360 percent.

Expensive

Some customers note, however, that the services are useful especially in emergencies, even if expensive. “It has met my objectives, financially, but it’s not the cheapest route,” said one Tucson CheckSmart customer.

How the different lending works

Storefront payday loan: The customer provided the lender a postdated check for the amount loaned, plus a fee. For example, the customer may have written a check for $200, plus an agreed-upon fee of 15 percent, or $30, for a total of $230. The lender provided $200 in cash to the customer. In an agreed-upon term, often two weeks, the lender took the principal and fee from the customer’s checking account.

Bank advance

Only existing bank customers with regular direct deposits, be they paychecks or benefit checks such as Social Security, qualify for these loans. The bank advances the customer up to $500 and charges a fee of between $7.50 and $10 per $100 advanced. The entire principal and fee are taken out of the customer’s next direct deposit at some banks even if that results in the account going into overdraft and accruing more fees. The bank will not “roll over” the initial advance but will issue a new loan with the same fee after the first loan is paid off, though some banks limit the number of consecutive loans.

Prepaid card

CheckSmart stores in Arizona are among many that sell prepaid debit cards – cards that you purchase by putting a certain amount on the card and paying a fee for the card. However, CheckSmart also offers two credit options for Arizona card users who make regular direct deposits to their cards, consumer advocates say.

Line of credit

The customer sets up the line of credit in advance, then pays $14 for every $100 cash borrowed. In addition, the outside bank that lends the money via CheckSmart, also charges 35.9 percent interest. The principal, fee and interest are taken out of the customer’s next direct deposit. Under this system, a 14-day loan of $100 would cost $15.38, or an equivalent of a 401 percent annual interest rate.

Overdraft

Customers with direct deposits to their prepaid card may also set up an overdraft protection service. The charge is 15 percent of the negative balance up to a maximum of $36 in fees, and the principal and fees are paid with the next direct deposit. Over two weeks, the 15 percent rate charged works out to an annual percentage rate of 391 percent.

The newly launched Payday Hound website advertises itself as offering “impartial and informed” reviews, comparing the rates and fees of dozens of online loan shops, including so-called payday lenders, pawn shops and other short-term lenders. But much of the site’s information raises alarms about the security of taking out online loans, consumer advocates said.

Illegal behavior

Of the dozens of sites listed on the Payday Hound, at least one has been charged by the Federal Trade Commission for illegal behavior. The site, 500FastCash, was sued by the FTC in early April for allegedly adding undisclosed and inflated fees, and collecting loans illegally by threatening borrowers with arrest and lawsuits. Though the Payday Hound gives 500Fast Cash a poor review, the Payday Hound still links to 500FastCash’s loan application.

Referral traffic

The Payday Hound appears to make money through referral traffic from desperate borrowers seeking fast cash. At the bottom of the site, a disclosure states, “The Payday Hound may be compensated if consumers choose to utilize the links located throughout the content on this site and generate sales for the said merchant.” The site is owned by a holding company called Contigo Limited LLC, based in Henderson, Nev., and the owner is listed as Con Way Ling, whose LinkedIn profile states his work experience includes three years serving as an officer at Signet Bank/Capital One. The company did not respond to multiple phone or email requests for comment.

Payday loans

Payday loans and similar high-cost short-term installment loans typically require steep origination costs, annualized interest rates from 300 percent to 900 percent, and high fees for refinancing the loan. Borrowers can often get a same-day loan with only a bank account number and basic employment information. But what makes such online loans potentially more treacherous for borrowers than their brick-and-mortar counterparts is that the lenders involved have direct access to borrowers’ bank accounts and their default payment structure typically requires the consumer to pay only interest in the first payments, Fox said.

Hazard

“The hazard here is that you grant lender access to your bank account and you don’t know how much you will pay back by the time you are done,” Fox said. Borrowers think they are paying down principal, when in fact they are just paying interest. “Many of these lenders require you to manually set it up to make a principal payment.”

Predatory

Consumer advocates have railed against payday loans as being predatory for the poorest borrowers because of excessively high interest rates and fees. So far, 17 states have taken actions to close or clamp down on payday lenders. But supporters of payday lending say these kinds of loans provide a much needed source of funds for borrowers who can’t get an emergency loan anywhere else. State regulations are hard to enforce on online operators since many are headquartered offshore or on Native American reservations in an attempt to skirt U.S. regulations altogether. Many of these are listed on the Payday Hound site.

A bill to regulate and monitor payday loans in Delaware has narrowly cleared the state House and is headed for the Senate. The House voted 26-to-7 for the bill Tuesday, giving it one more vote than the required three-fifths majority.

The bill

The bill would permit a borrower to obtain no more than five payday loans in a 12-month period and would limit a lender to no more than four rollovers of an existing payday loan. The bill also calls for the creation of a database overseen by the state that lenders would use to determine whether a potential borrower already has an outstanding payday loan.

Payday loans

Payday loans typically are small, short-term loans with high interest rates that effectively represent advances on a borrower’s next paycheck.

In a meeting Wednesday night, San Jose’s planning commission will consider a proposal to bar payday lenders from setting up shop in low-income neighborhoods. Next Tuesday, Santa Clara County supervisors will decide whether to make their temporary ban on all new payday lending establishments permanent. “We’re zoning them out of existence,” said Supervisor Dave Cortese. “This isn’t spot-zoning or redlining certain areas. We’re saying we don’t want them anywhere.”

Increases

Although the number of storefronts has declined in California in recent years, the number of payday loans from 2006 to 2010 grew from 10 million to 12 million, with the number of customers increasing from 1.4 million to 1.6 million. In 2010, $3.1 billion in payday loans were issued in California. Frustrated with the lack of action at the state level, many local communities are now trying to tackle the problem on their own. Although they cannot cap interest rates, cities and counties can change land-use and zoning laws to make it harder or impossible for payday loan businesses to set up shop.

Demand will continue

Greg Larsen, spokesman for the California Financial Service Providers Association, said that eliminating legal, state-regulated payday lending or making such loans harder to obtain will not decrease the need for short-term credit. “The demand will continue,” he said in an email, “with some consumers possibly forced to use easily available, unregulated, online, overseas lenders with much higher costs, greater risks and unknown collection practices.”

No new applicants

San Jose city leaders are so far considering something short of a total ban or cap. If the current proposal is recommended to the City Council on May 15, new applicants would not be allowed to move into low-income neighborhoods but could open elsewhere in the city. They would have to stay only 500 feet from other payday lending establishments, not the 1,000 feet or more required in other cities that have tried to rein in payday lending. And there would be no limits on their proximity to liquor stores, bars and “adult” businesses.

Restrictive terms

Some city leaders have indicated they want more restrictive terms. City Councilman Ash Kalra and Planning Commission Chairwoman Hope Cahan said they would consider a hard cap on the number of payday lenders or a moratorium on future businesses. Laurel Prevetti, San Jose’s assistant director for planning, building and code enforcement, described the ordinance her office drafted as unique, given that it would specifically protect low-income residents from having more new payday lending establishments in their neighborhoods.

Tax season is upon us in full force. There is a mountain of receipts on the kitchen table, midnight news reports from the post office and, of course, all those wacky come-ons from tax preparers promising easy money. There are “FA$T CA$H” banners plastered on storefronts, and a boom in advertising hype, all ending with advice on how to avoid a similar mess: “Just come on down to Mo’ Money!”

Refund anticipation loans

These refund anticipation loans have been risk-free business for most of the past decade. Lenders offer roughly 10-day advances of tax refunds, for which they charge exorbitant subprime fees. More than 12 million taxpayers got anticipation loans in their peak year, in 2004, according to the National Consumer Law Center. IRS data shows that over 90 percent of people who applied in 2010 were low-income. Don’t be fooled, though, refund anticipation loans are no fringe market. Throughout the so-called boom years, the same banks that sit at the center of our high-end economy spread this fraud-ridden industry throughout its bottom tier. Take for instance Mo’ Money, which has faced several fraud probes. Until 2010, its storefronts were actually agents of JPMorgan Chase. The bank backed roughly 13,000 independent preparers in this business. But as of Apr. 30, no banks will remain in the refund loan market. They’ve been driven out by a combination of watchdog advocacy and renewed regulatory oversight.

Low-income communities

‘Refund anticipation loans’ are part of a pack of predatory financial products that feed off low-income communities, and in particular black neighborhoods that struggle for access to fair credit. Now, financial players at all levels are looking for new twists on the old idea: risk-free money at the expense of the working poor.

Shut down

In the summer of 2010, the IRS shut down its debt indicator tool. Without that safety mechanism, the FDIC ruled that the remaining banks couldn’t make refund anticipation loans. Just one, Republic Bank & Trust, fought back in court; it lost that fight in large part because FDIC presented evidence of fraud in Republic’s loan program. The bank settled with FDIC at the start of this year’s tax season and agreed to make its last refund anticipation loan by Apr. 30, 2012.

Low-income neighborhoods

Drive through an urban area’s low-income neighborhoods, particularly in the South. You’ll find what consumer advocates call a “payday alley” in just about every one. It’s a strip of storefronts offering high-interest loans against a borrower’s next paycheck. They’re lined up cheek by jowl with refund anticipation outlets, pawnshops and Walmart stores. Researchers ranging from academia to the Department of Defense have identified payday loans as debt traps that keep low-income borrowers cycling through new loans, week after week for years at a time.

Consumer watchdogs

Banks are eager to define their “advance” products as anything but a loan; the CFPB was clear it is a payday loan just like any other. But consumer advocates are eager to get the attention of traditional bank regulators, which still carry more authority. “It took a while on refund anticipation loans,” says the Center for Responsible Lending’s Kathleen Day. “It took a while, and a recession, before they did their job on mortgage lending. And our basic message is we don’t want them to wait” on bank payday lending, too.

A Tracy man is accused by the Federal Trade Commission of masterminding a massive debt collection scam that placed more than 2.7 million calls. The FTC says he scammed more than $5.2 million from consumers, many of whom were strapped for cash and thought the money they were paying would be applied to loans they owed.

The accused

Accused is Kirit Patel of Tracy. He and two companies he controls are charged with violating the FTC Act and the Fair Debt Collection Practices Act. Pretending to be American law enforcement agents such as “Officer Mike Johnson” or representatives of fake government agencies like the “Federal Crime Unit of the Department of Justice,” callers from India who were working with the defendants would harass consumers with back-to-back calls, according to the FTC in papers filed with a federal court. The scheme targeted consumers who previously applied for or received loans from payday loan companies.

The victim

A victim said, “The callers threatened me and claimed they would arrest me if I didn’t pay them the alleged debt. One of the callers even contacted my neighbors and told me he was watching my house. The callers had a lot of personal information about me. One caller told me, ‘We just saw you walk into your office building,’ and then listed my office address. Another caller told me there were 55 warrants out for my arrest. Sometimes my caller ID would indicate that the call was from the FBI. Because the callers knew so much about me, I believed they were police officers or FBI agents.”

Payday loans

In difficult economic times, consumers may turn to high-interest, short-term payday loans between paychecks. The FTC alleges that information submitted by consumers who applied for these loans online found its way into the defendants’ hands. Because the callers had this information, which often included Social Security or bank account numbers, and because many of the victims already were in a tenuous financial situation, they often believed that they owed the defendants the money, according to the FTC.

The demands

The defendants typically demanded several hundred dollars and, in violation of federal law, routinely used obscene language and threatened to sue or have consumers arrested, according to the FTC’s complaint. They also threatened to tell the victims’ employers, relatives, and neighbors about the bogus debt, and sometimes followed through on these threats, the FTC alleges.

Debit cards

Once victims were pressured into paying, the callers instructed them to use a pre-paid debit card, a credit card, or Western Union so the money could be deposited into one of the defendants’ merchant processing accounts, the FTC alleges. Even after victims made a payment, the harassing calls often continued, forcing them to change their phone numbers, or close their credit cards or bank accounts in an effort to get the calls to stop, according to documents filed with the court.

A federal RICO class action claims the owner of a payday loan company, a felon, used a “rent-a-tribe” scheme to avoid civil and criminal liability for his illegal loan practices.     Lead plaintiff Larry Robinson claims defendant Scott A. Tucker, of Leawood, Kan., is not licensed to issue payday loans in Kansas and cannot get a license for it because he is a felon.

Illegal payday loans

But Tucker “organized, owns, operates, manages, and controls various payday loan trade names, including ‘United Cash Loans,’ which are in the business of providing illegal payday loans to consumers over the Internet,” from an office in Overland Park, Kansas, Robinson says in the complaint. He claims Tucker circumvented the system through a rental agreement with the Miami Tribe of Oklahoma in 2003, and with the Santee Sioux in 2005.

Santee Sioux Nation

Robinson says, “In early 2005, defendant Scott Tucker approached the Santee Sioux Nation to discuss a proposal to create a structure to ‘rent’ the tribe’s legal immunity for his illicit payday loan businesses. “Defendant Scott Tucker and CLK Management, LLC exclusively operated, managed, and controlled the payday lending operations, while paying the Santee Sioux Nation a monthly fee of 1 percent of gross revenue or $20,000 per month to use their name and purported immunity.”

Post office boxes

Robinson claims that Tucker operates “various payday loan trade names, including ‘United Cash Loans,’ and CLK Management LLC from an office building at 10895 Lowell Avenue, Suite 100, Overland Park, Kansas 66210,” which is not on tribal land. He adds: “Defendant Scott Tucker has obtained post office boxes on various tribal territories or reservations throughout the United States of America for use by his various payday loan trade names.

Payday loan

Robinson says he got a $300 loan from Tucker, with an annual interest rate of 608.33 percent, well above the maximum interest rate allowed by Kansas law. The class consists of anyone who got a payday loan from Tucker and the various trade names he owned, operated, or contracted with. Robinson seeks treble damages and punitive damages for usury, violations of the Missouri Merchandising Practices Act and/or the Kansas Consumer Protection Act and RICO violations.