The holidays can be especially stressful for those on a tight budget. For someone living check to check, it is tempting to consider borrowing to finance a few gifts or to cover additional expenses. Many of us think of credit cards as the obvious solution, as long as we pay off the balance immediately.
But a certain segment of the working population without access to retail credit will be enticed to consider a pernicious alternative: payday loans.
Sometimes referred to as check cashing services or cash advance stores, payday lenders provide phenomenally expensive short-term loans. There are an estimated 20,000 loan stores in the United States, plus a growing number of online operations competing for the attention of the less sophisticated and most vulnerable members of the working poor. According to an industry analyst, payday lenders made over $40 billion in loans and reaped $7.4 billion in revenue last year.
financial reform mandated several new regulations relating to credit cards, but notably failed to curtail the usurious practices of the check-cashing industry. Seventeen states (including Georgia) have outlawed these businesses altogether, but regrettably Tennessee is not one of them.
Tennessee and several other states have constrained the most abusive practices of these entities by restricting the number of loans that can be made to an individual, capping the maximum loan amount, and limiting the effective interest rate (albeit at still penury-inducing levels).
Remarkably, at least 30 of these lenders are owned by Indian tribes and are therefore exempt from state laws regulating the industry.
The folly of a payday loan can be seen in the following typical example. A borrower writes a post-dated check to the lender for $500, and receives a loan for $425, at a nominal interest rate of 17.65 percent. When the loan comes due (typically in 14 days), either the borrower must repay the loan with fees and interest, or the lender will deposit the post-dated check. In case you thought credit cards had high annual interest rates at 36 percent, check out the payday lender at an APR of 459 percent.
Furthermore, if the borrower cannot repay the loan when due, he may also become liable for bounced check charges when the lender deposits the check, and then become the target of collection action and potentially of civil prosecution. For this reason, payday lending is often referred to as a "debt trap" from which a victim is hard-pressed to escape.
Tennessee has the unsavory distinction of being one of the birthplaces of payday lending. The business is extremely profitable and has so far been successful at fending off efforts to bring the industry under the usury laws to which legitimate lenders are subject.
For someone considering a payday loan to pick up a few Christmas gifts, or to pay a couple of bills during the holiday season, take this advice: Don't. Alongside furniture rent-to-own and title pawn stores, payday loans are a one-way trip to the poorhouse.
Christopher A. Hopkins, CFA, is a vice president at Barnett & Co. in Chattanooga.