Payday and Auto Title Lending

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1 Payday and Auto Title Lending LBJ SCHOOL OF PUBLIC AFFAIRS Center for Politics & Governance Executive Summary Payday and auto title lending is a fast growing industry in Texas. 1 In 2004, there were approximately 1,300 payday-lending locations in Texas. By 2010, that number increased to 2,700, an increase of more than 100%. Currently, there are approximately 1,800 auto title lending locations in Texas. 2 Payday and auto title loans are high cost loans requiring the payment of fees amounting to an average of 391% Annual Percentage Rate (APR) 3 and have short loan terms (usually 2 to 4 weeks for payday loans and sometimes up to one year for auto title loans) at the end of which the full principal must be repaid. 4 Payday and auto title loans do not require credit checks and provide fast access to cash; however, consumers who use these loans tend to have lower incomes and often experience difficulty in repaying their loans at the end of the loan terms. 5 The 82nd Legislature passed legislation establishing licensing and data reporting requirements for payday and auto title lenders, to provide better information regarding the prevalence of payday and auto title lending in the state and the costs of these loans to consumers. Advocates for fair lending practices in the payday and auto title lending industry in Texas believe more needs to be done to limit what they consider the propensity of payday and auto title loans. They believe these loans trap consumers in a cycle of debt due to the short loan terms and lump sum repayment requirements. Specifically these advocates want a cap on the fees that are charged for these loans. Proponents of payday and auto title loans say that they must charge high fees because they have high operating costs and a large number of borrowers default on their loans. They argue that limiting access to payday and auto title loans could result in consumers using credit alternatives that are even more expensive, such as writing a bad check or going over the credit limit on a credit card. 6 They further argue that these lending services may be the only access to credit that many borrowers have. 7 Background Payday loans are small-dollar, short-term loans where the loan is required to be repaid in full usually in two weeks or on the borrower s next payday. On average, payday loans nationwide range from $100 to $500 and borrowers are charged a $15 fee for every $100 borrowed, which amounts to an APR of 391%. 8 Although payday loans have short loan terms, borrowers often remain in debt much longer because the terms of the loan require 1

2 principal repayment in one lump sum. 9 Borrowers often find it difficult to repay the full principal in one payment and renew or refinance their loans or take out a new payday loan to cover expenses. Borrowers are required to pay a fee every time they refinance. Consequently, refinancing a payday loan over several or more months can result in a borrower paying fees that can equal or exceed the loan amount. 10 Auto title loans are similar to payday loans in that they are short-term and require repayment usually after 2 to 4 weeks. Whereas payday loans are secured through the borrower s next paycheck, auto title loans are secured through a car title. 11 If a borrower is not able to repay an auto title loan, his or her car can be repossessed. Payday and auto title loans are offered through storefront locations technically referred to as credit service organizations (CSOs) or credit access businesses (CABs). National CSOs, payday or auto title lenders that have locations in multiple states, tend to charge the maximum fee as permitted by state law, which means a $500 payday loan from the same CSO could cost $55 in Florida and $100 in Texas. 12 Payday loans also are offered online, but online payday loans are not as prevalent as storefront payday lending. Demographics of Payday and Auto Title Borrowers in Texas Women are the largest consumers of payday loans in the state of Texas, taking out 54% of all payday loans. Breaking the demographic groups down further we see that 22% of loans go to white females and 32% to non-white females. The largest single group of payday borrowers is non-white males who take out 36% of all payday loans, while white males account for only 10% of loans. 13 Non-white borrowers with an income below $35,000 per year comprise 41% of all borrowers. That number increases to 50% of borrowers for incomes up to $50,000 per year. 14 This means that 18% of payday borrowers are minorities who make over $50,000 per year. Auto title loans have a slightly different demographic with the majority of borrowers being male (56%), though non-white males are once again the largest group to use these loans. 15 Approximately one-third of all payday and auto title loan borrowers are between the ages of 24 and 35, making them the largest age group to use these types of loans in Texas. The next largest age group to use these loans is between the ages of 35 and 44. People over the age of 55 take out a similar number of payday loans as those aged 18 to 24, though the older group takes out nearly three times as many auto title loans as the younger group. 16 Why Consumers use Payday & Auto Title Loans In a Pew survey of payday loan borrowers, most respondents (69%) used these loans to pay for recurring expenses and 16% used them for unexpected expenses. Of those who used payday loans for recurring expenses, 53% used these loans for expenses such as credit card payment, utility bill payments and car payments. Ten percent used them to pay 2

3 rent and 5% used payday loans to buy food. The Center for Financial Services Innovation (CFSI) survey of small-dollar credit (SDC) consumers found that over 30% of SDC consumers used SDC products to cover general living expenses such as food and clothes and over 35% used them to pay utility bills. 17 CFSI s definition of SDC products includes payday loans, pawn loans, direct deposit advance loans, auto title loans and non-bank installment loans of $5,000 or less. 18 The most common reasons that prompted the use of an SDC product were a bill or payment was due before arrival of the paycheck, an unexpected expense and general living expenses exceeding income. 19 Advantages of Payday & Auto Title Loans An individual in need of funds who is unable to receive a payday loan may choose instead to either write a bad check or overdraft his debit card. Both of these options can be more costly to the borrower than a payday loan the average fee for a bounced check in 2010 was $30.47, 20 and the overdraft fee on a debit card generally costs $30-$ Additionally, writing a bad check can result in the writer being sued in court and possibly serving jail time. Opponents of payday and auto title loans argue that other, more affordable sources of credit may be available to borrowers. These alternate credit options include loans from family and friends or a traditional bank loan. However, some borrowers may not have friends or family members who are willing (or able) to loan them the necessary funds. Furthermore, most banks do not loan small dollar amounts such as those borrowed from payday lending institutions. Credit cards are another alternative to taking out a payday or auto title loan, but according to a 2007 survey of payday customers, about half of all borrowers do not have access to a credit card. Of the half who had a credit card, 40% said that putting their most recent payday loan on their credit card would cause them to go over their credit limit, (resulting in a fee charged to their account which may be greater than the cost of a payday loan). 22 Finally, proponents of payday lending point out that the use of payday and auto title loans may protect a consumer s credit. This is due to the fact that payday lenders do not report to credit bureaus. This means that even if borrowers default on their payday loans, their credit score should not be adversely affected the way it might be if they bounced a check or over-extended their credit. Disadvantages of Payday & Auto Title Loans One of the biggest disadvantages to payday and auto title loans is the high cost associated with them. The APR for these loans, especially in states without legislation capping payday and auto title loan fees, often exceeds the national average of 391%. Borrowers often do not understand the actual APR of their loan because of the fee structure. Payday and auto title loan fees are usually a certain dollar amount charged per $100 loaned. A fee of $15 per 3

4 $100 may appear to a borrower to be a 15% interest rate but in actuality amounts to an annual interest rate much higher than that even when the loan is fully repaid within the initial loan term. Another disadvantage of payday and similarly structured auto title loans is that they rely on refinancing and repeat borrowers to be profitable. The small dollar amounts and short repayment terms of payday and auto title loans, even with the high fees charged, do not yield profits unless there is a high loan volume. 23 This leads some payday lenders to offer borrowers incentives to continue taking out these loans such as discounts for referrals and repeat borrowing. 24 This is problematic given that many payday loan borrowers are susceptible to accumulating an unmanageable amount of debt because of difficulty in repaying the full principal and fees in the initial loan term. Opponents believe that the industry s reliance on repeat borrowing is not in the best interest of the consumer and can be considered predatory depending on how high the fees are and whether complete information about these fees is disclosed to borrowers. What You Need to Know about Payday Lending in Texas Texas Laws on Interest Caps for Lending In an attempt to protect consumers from usurious lending Article 16, Section 11 of the Texas Constitution caps interest rates at 10%. 25 Chapter 342 of the Texas Finance Code allows the Texas Legislature to set interest rates that are even higher for subprime consumers. These rates are not to exceed a $10 fee for the loan and 4% of the loan amount per month. This results in an effective interest rate of %. 26 Legal Loophole Payday and Auto Title Lenders use to Bypass Interest Rate Cap Payday and auto title lenders are able to get around the legal interest rate cap because they do not technically extend credit. Rather, they act as a middleman working to connect borrowers with a third-party lender and, therefore, are exempt from the limitations outlined in the Texas Constitution and the Texas Finance Code. This allows them to charge high fees on short-term loans without breaking any laws. Some local governments in Texas have assumed the task of limiting the presence of payday and auto title lenders within their city limits. Austin, Dallas and San Antonio passed ordinances that limit where payday and auto title lenders can operate. 27 Austin and Dallas also passed ordinances that institute some consumer protections to help prevent consumers from being trapped in a debt cycle that often results from taking out these types of loans. 28 4

5 Effects of Legislation Passed During the 82 nd Legislative Session Legislators passed two bills, H.B and H.B. 2594, addressing payday lending in H.B addresses pricing disclosure by requiring CABs to disclose to customers the cost of loan refinances and the amount of time it takes most customers to completely repay their loan. 29 H.B requires CABs to apply for a license from the Office of the Consumer Credit Commissioner (OCCC) for each physical location they have. The license application requires CABs to provide OCCC with information such as staff names, products offered and third-party lenders they work with to provide loans. 30 The legislation also requires CABs to submit quarterly and annual data to the OCCC on the number of each type of product offered, number of refinances for each type of product, the dollar amount of fees charged for loans and refinances and other related information. 31 Financial Implications Legislation that significantly restricts payday lending either by capping the amount of each fee that can be charged or limiting the amount of payday loans that can be extended to a single customer each year, can result in diminishing profitability of these loans. This can lead to CSOs closing a number of storefront locations in a state. 32 In Pew s survey, if payday loans were unavailable, most borrowers reported they would use a variety of options to cover expenses. Among alternatives to payday loans, 81% of respondents reported they would cut back on expenses; 62% reported they would delay paying some bills and 57% reported they would borrow from family or friends; and 57% reported they would sell or pawn personal possessions. 83rd Legislative Session Outlook Legislation that Interest Groups May Attempt to Get Introduced A coalition of more than 36 organizations including the Texas Fair Lending Alliance and Texas Faith for Fair Lending have joined together to advocate for stricter laws governing payday and auto title lending institutions. Their goal is to convince legislators to cap interest rates on these loans at no higher than 36% APR. Public support is in their favor as a recent poll conducted showed bi-partisan support of an interest rate cap. A full 75% of registered voters polled were in favor of legislation that would decrease the cost to consumers of these loans. This poll had a 3.4% margin of error. 33 The ordinances passed by some cities in Texas pose issues for payday and auto title lenders in terms of being forced to comply with different laws in different municipalities. The Texas Municipal League has advocated for the preservation of local control regarding payday lending ordinances while lobbyists for payday and auto title lenders favor uniformity of law, which would require municipalities to follow state laws regarding the regulation of payday and auto title lenders. If the Texas Municipal League is successful during the 83 rd 5

6 legislative session in advocating for preservation of local control over this issue, this could place pressure on the payday and auto title lending industry to modify their loan products and business practices to avoid the complexity of having to comply with a range of different local regulations. 34 Challenges to Additional Legislation Representative Vicki Truitt, as chair of the House Pensions, Investments and Financial Services Committee during the 82 nd legislative session, played a key role in enabling the passage of H.B 2592 and H.B Truitt is one of several Texas House members who were not re-elected to office in the last election. With nearly half of the incoming Texas House members serving their first or second term, advocates of stricter payday and auto title lending legislation are challenged with re-educating legislators and re-building support in the House for further legislation addressing payday and auto title lending. Additional legislation favored by fair lending advocates includes capping the amount in fees that can be charged per loan and limiting the number of times consumers can refinance these loans to lessen the high cost of accumulated refinancing fees Baddour, Ann, Rebecca Lightsey, Janis Monger and Matt Coleman. Reshaping the Future of Small-Dollar Lending in Texas: Alternatives to High-Cost Payday and Auto Title Loans. Austin: Texas Appleseed, Ibid, 7. 3 Pew Charitable Trusts. Payday Lending in America: Who Borrows, Where They Borrow, and Why. Washington, DC, Texas Appleseed, 8. 5 Pew, 2. 6 Edmiston, Kelly D. Could Restrictions on Payday Lending Hurt Consumers? Economic Review First Quarter 2011 (2011): Ibid., Pew, 6. 9 Ibid., Ibid., Texas Appleseed, Pew, Texas Appleseed, Ibid., Ibid., Ibid., Levy, Rob and Joshua Sledge. A Complex Portrait: An Examination of Small-Dollar Credit Consumers. Chicago: Center for Financial Services Innovation, Ibid., 7. 6

7 19 Ibid., Edmiston, "A Further Look at Overdraft Fees." The New York Times, sec. The Opinion Pages, February 27, 2012, A Edmiston, Ibid., 67. Pew, Pew, Article 16 in The Texas Constitution, added November 3, Accessed October 30, Texas Appleseed, Two Major Coalitions Team Up. 28 Ibid. Texas Appleseed, Texas Appleseed, Texas Appleseed, Office of Consumer Credit Commissioner, accessed October 30, Pew, Two Major Coalitions Team Up. 34 Ann Baddour, Don Baylor. Payday and Auto Title Lending. Classroom presentation, Texas Legislature, LBJ School of Public Affairs, Austin, TX, November 1, Ibid. 7

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