442 percent is 406 percent too high

Critics have a name for payday loans: legal loan-sharking. That’s harsh, but it’s not an entirely inappropriate description for annual interest rates on loans that, according to one Missouri state regulatory survey, hit 422 percent.

At a news conference in St. Louis recently, Missouri Attorney General Jay Nixon restated his support for state legislation that would limit the annual interest rate on payday loans to 36 percent — the same limit placed by the U.S. Congress last year on payday loans to members of the military.

Mr. Nixon’s appearance had political overtones — he is expected to be the Democratic nominee for governor in 2008 — but that doesn’t invalidate the importance of cracking down on exploitive payday loans.

Consider a little background:
People who take out payday loans generally are working-class folks with shaky credit and cash flow problems. They turn to payday loans when bills come due and money runs short near the end of a pay cycle. Storefronts and offices, often situated near military posts, offer short-term loans in amounts that rarely top $500. In Missouri, a typical shop will charge a $17 fee for a two-week loan of $100. In Illinois, the fee is capped at $15.50 per $100.

Problems start when loans comes due and borrowers can’t pay them back. In those cases, payday lenders usually offer to roll over the loan for another two weeks for another $17. Thus, a $100 loan becomes a $134 debt after two weeks, $151 after a month and so on. Convert those fees to an annual basis, and they equal an interest rate of about 400 percent.

In Missouri, the average payday loan is renewed twice. State law allows up to six renewals, but caps total interest at 75 percent of the original loan.

Mr. Nixon supports legislation that would permit one $15 charge per $100 on a 30-day loan — less than half of what the average lender charges now — with no renewals. Lenders could charge 3 percent per month on unpaid balances.

Three percent per month equals 36 percent a year. Lenders say they can’t live on that. "A 36 percent annual percentage rate is a show-stopper for the industry," said a Missouri spokesman for the Consumer Financial Services Association, the payday loan lobby.

But a 36 percent rate hasn’t seemed to have stopped the show on loans to active-duty service members. The new provisions passed by Congress last year took effect Oct. 1. They limit annual interest rates to 36 percent, including all fees. They also prohibit lenders from requiring borrowers to provide post-dated bank checks or other access to a customer’s bank account.

Dire warnings in the face of tighter regulation seem to be standard practice for the payday loan industry. In 2005, Illinois enacted a fairly stringent law covering payday loans. It limits fees to 15.5 percent on a two-week loan and allows only two roll-overs for a total of 45 days. If the borrower can’t pay, he can demand an eight-week grace period in which to pay off the debt, with no additional interest accrued.

Despite alarmist complaints issued at the time, the industry is living with the law. The state says 763,000 payday loans were made in the past 18 months. "The assertion that the industry would collapse was not true," says Dean Martinez, Illinois secretary of financial and professional regulation.

The payday loan business provides a useful service for those who find themselves in a temporary financial squeeze. But that’s not justification for exploiting people when they’re vulnerable and trapping them in a cycle of ever-mounting debt. The industry can exist profitably with reasonable regulations, which is what the Missouri Legislature should enact when its next session begins in January.

Source: St Louis Post-Dispatch