Poverty at Issue is published by Brenda Procter, Consumer and Family Economics Specialist, 162 Stanley Hall, Columbia, MO 65211 573-882-3820 POVERTY At Issue Fall - Winter 2005 A newsletter for individuals concerned about poverty in Missouri In this Issue Credit At Issue - When Creditors are Predators... 1 What is Predatory Lending?... 2 Why Does Predatory Lending Exist? Is It Really That Widespread?... 2 What Questions Do I Ask Lenders to Get the Best Deal?... 3 How Can You Tell if a Lender is Predatory?... 4 Do Consumers Have Rights?... 4 How Do Predatory Lenders Find Borrowers?... 5 Payday Lending... 6 Title Lending... 6 Rent-to-Own Lending...6 Pawn Shop Lending...7 Subprime Mortgage Lending...7 Credit At Issue When Creditors are Predators It is difficult for those who do business with mainstream financial institutions like banks, credit unions and savings and loans to understand why anyone would ever pay the high interest and fees associated with subprime lending. What those who have less than perfect credit understand all too well is that mainstream institutions are not always an option. This Poverty At Issue explores the practices of predatory lenders. While most lenders are reputable and responsible, too many make a profit from people s unstable financial conditions. Predatory practices are most often associated with subprime mortgage, payday, title, pawnshop and refund anticipation lenders, but such practices might be found elsewhere as well. This Poverty At Issue would not have been possible without strong research support from Suzi McGarvey, Extension Associate in Personal Financial Planning Extension. Many thanks to her. A special thank you is due Bailey, who told her personal story and whose real name was not used to protect her identity. It took courage for her to share her story, but others will surely benefit from the lessons she learned the hard way. I hope you find this information helpful. Brenda Procter Refund Anticipation Loan...7 Personal Stories...8 Bailey Tells Her Story...8 Consumer and Family Economics Specialist Sources... 10 equal opportunity/ada institution
What is Predatory Lending? Predatory lenders deceive, manipulate, apply pressure or engage in fraud to get a borrower to take out a loan. A predatory loan has terms that put the borrower at a big disadvantage, and usually has excessive interest rates and hidden terms and costs that the borrower does not understand. Predatory lenders deceive, manipulate, apply pressure or engage in fraud to get a borrower to take out a loan. In spite of an alarming increase in the number of predatory lenders, most financial institutions in this country operate within the law and do not prey upon the people they serve. Most lenders are not out to trick you but unfortunately many are. Predatory lending abuses could be found in any kind of institution, but such abuses are most often associated with rentto-own contracts, pawn shop loans, payday loans, subprime mortgages, tax refund anticipation loans, overdraft loans, and car title loans. 1 Why Does Predatory Lending Exist? Is It Really That Widespread? Many factors work together to help predatory lending flourish. A lack of financial education for the general public contributes to the problem. Opportunities are created for predatory lenders when families have or perceive that they have no better options. Entry level jobs often do not pay enough to support an individual, much less a family. At today s $5.15 per hour minimum wage, a single parent with two children working full time would remain below the poverty level. That parent would need $7.74 an hour to even get to the poverty line. 2 A wage as high as $27.04 an hour is necessary to make ends meet in some high cost areas of Missouri. Underemployment, estimated at 9.6% of the workforce in 2004, is also a problem. 3 Families who have low incomes struggle to meet their own financial needs. They may have problems with their credit history or lack experience with mainstream financial institutions and the language they speak. It is easy for someone who lives in or near poverty to fall prey to unscrupulous lenders who take advantage of unstable situations. New predatory lenders, including on-line lenders, are popping up every day. Debt in our country has been steadily increasing. Between 1990 and 2001, credit card debt more than doubled. From 2001 to 2004, credit card debt grew from $703.9 billion to $800.1 billion. Debt has been growing most rapidly among senior citizens, adults under age 34, and low-and middle-income consumers. 4 The savings rate has declined. According to the Federal Reserve, more than four in ten U.S. families spend more money than they make. The U.S. Department of Health and Human Services reports that nearly all Americans will be financially dependent on the government, family or charity when they retire. The average personal savings rate in the U.S. in 2003 was 1.4%. 5 Bankruptcy is on the rise 37,251 non-business bankruptcies were filed in Missouri in 2004 up from 13,530 in 1990. 6 Missouri ranks 15th in the number of bankruptcies per 100,000 population. 7 Tennessee 2 Poverty at Issue Fall/Winter 2005, Curators of the University of Missouri
has the highest rate at 1,049 per 100,000 population. As prices of basic needs from gasoline to school supplies to health insurance rise, it is more and more difficult for people to take care of their families. Increases in prices, a higher debt load, and lower savings rates make families financially vulnerable. One family emergency can cause a financial crisis. Many families struggle to find mainstream sources for credit and loans. Twenty-two percent of U.S. low-income families (over 8.4 million families earning under $25,000 per year) do not even have a bank account. 8 Banks and other traditional financial institutions have avoided locating in low-income areas due to perceived higher credit risks. It is easy for someone who lives in or near poverty to fall prey to unscrupulous lenders who take advantage of unstable situations. Most financial institutions do not make short-term, small loans, and many consumers have serious enough credit problems that mainstream institutions are not an option. The only options many consumers feel they have are payday lenders, auto title lenders, pawn shops and subprime mortgage lenders. Unfortunately, such lenders sometimes engage in predatory practices. The subprime mortgage industry has grown by 1000% over the past ten years, according to the Center for Responsible Lending. Borrowers lose an estimated $9.1 billion annually on predatory mortgages, $3.4 billion on payday loans, and $3.5 billion on other lending abuses like overdraft loans, excessive credit card debt and tax refund loans. 9 What Questions Do I Ask Lenders to Get the Best Deal? Asking the right questions before agreeing to a loan can help you fully understand what you are committing to. Consider asking questions like these before applying for any kind of loan: What papers or information will I need to apply? What fees will I need to pay up front? How long will it take to process my application and get me my money? What are the total fees I will pay for the loan itself and all related requirements? What will be the Annual Percentage Rate (APR) when you include all fees associated with the transaction? How much interest will I pay over the life of the loan? Does the interest rate stay the same for the entire loan? What will be my monthly or weekly payment? Can I make extra payments or pay the loan off early without penalty? Will my payments ever increase? If so, why? Are there extra fees if I pay late? Where do I make my payments? How long is the loan? Is there a large lump-sum payment at the end of the loan? Can I have a copy of a Good Faith Estimate or a written statement with all the fees and loan terms listed? How long has your company been in business? Who do I contact if I have questions about my loan? What agency or office regulates you as a lender? (For pawn shops only) How much will you charge for insuring Poverty at Issue Fall/Winter 2005, Curators of the University of Missouri 3
and storing what I am pawning? Are there any other extra fees besides the interest? Any reputable and honest lender should be more than happy to answer your questions. Their hesitancy to do so is a red flag in and of itself. If possible, get information from at least three lenders before making a decision to borrow. You may decide that every store s fees are too high and rethink the loan. Sometimes waiting to spend the money or coming up with it another way may make more sense once you fully understand the costs. No matter what kind of lender you plan to do business with, learn about your rights, ask lots of questions and take enough time to get the best deal you can when you borrow from them. If it is possible, wait to spend the money and pay yourself (save) a little each paycheck to get the money you need without borrowing. Consider selling something you don t use or asking close friends or relatives if you can t wait. If you decide that borrowing is the only way, at least you will be able to get the best deal, using the questions above and taking a little time to compare. How Can You Tell if a Lender is Predatory? A few basic signs help you recognize when a lender is using predatory practices. These are some red flags that should make any consumer wary: The lender pressures you to accept an offer. You received a call or a letter offering you a loan. This was not information you asked for. You get approved for a loan that is more than you wanted. You know you cannot make the payments you have been approved for. The loan agreement says you must pay everything back at once instead of in regular, smaller payments. Do Consumers Have Rights? There are few laws to protect consumers from predatory practices. In Missouri, for example, rent-to-own store fees are not subject to regulation. Stores can charge whatever effective annual percentage rate (APR) they want--as rental fees. Payday loan stores must disclose their APRs but there is no limit. In 2004, the average APR for Missouri payday loans was 408.3%. 11 Pawn shops and car title lenders have regulated APRs, but they are allowed to charge whatever they want for storage and insurance fees for merchandise in their possession. 12 Predatory subprime mortgage lenders are free to The lender ignores your questions about loan terms. There are unknown costs in the loan or rental papers. You have to buy credit insurance to be approved. You cannot pay off the loan early without a penalty. You do not have the right to sue if something goes wrong. The interest rate is very high. The lender asks you to sign blank papers that he or she will finish later. The lender pressures you to refinance several times a year. Your monthly payments become higher instead of lower. 10 charge whatever they choose for upfront costs, even if the fees are disproportionate to the additional risk they assume with bad credit borrowers. 13 It is easier for predatory lenders to take advantage of consumers who do not understand their rights or what businesses are and are not allowed to do. Consumers who come armed with information make clearer, more rational decisions and get the best deal possible no matter what type of lender they are dealing with. While regulation may not offer consumers the protection that many would want, there are still specific things you can do to help you get the best deal. 4 Poverty at Issue Fall/Winter 2005, Curators of the University of Missouri
How Do Predatory Lenders Find Borrowers? One reason predatory lenders have been so successful is that they know how to find new customers. Predatory mortgage lenders often make cold calls to people to refinance their homes. Sometimes, people agree to refinance even if they had not thought of doing so before. Advertising often fails to include all the terms of the loan or prints details in such fine print that it is difficult to read. Specific minority groups have been hit hard by predatory lenders advertising. Lenders often apply great pressure to borrowers to get them to agree to a loan. Borrowers may be told that special loan rates will not be available much longer or that there is no guarantee that they will be approved again at a later time if they do not sign a contract now. Advertising often fails to include all the terms of the loan or prints details in such fine print that it is difficult to read. Ads, sometimes in both English and Spanish, may use legal jargon that is hard to understand. The focus in the ads is on low weekly or monthly payments instead of the actual high interest rates and other costs of borrowing. Other tactics some predatory lenders use are not quite as obvious. People who have used high-cost payday loans before have noted how kind the Subprime Mortgage Statistics: In 2002, upper-income African-Americans living in predominately African-American areas were 3 times more likely to have subprime mortgages than low-income white borrowers were. In 2002, Latinos and African-Americans were 2.5 and 4.1 times (respectively) more likely than whites to refinance through a subprime lender. Those age 65 and older are 5 times more likely to borrow from a subprime lender than someone younger than 35. It is estimated that up to 51% of refinance mortgages in African-American neighborhoods are subprime loan (compared to 9% of predominantly white neighborhoods). Poverty at Issue Fall/Winter 2005, Curators of the University of Missouri 14 employees were to them and how compassionate they seemed. If someone feels intimidated in a mainstream financial institution, such as a bank or credit union, the welcoming environment of a payday loan shop may make it much more comfortable to do business there. Payday loan stores, pawn shops and rent-to-own stores sometimes throw customer appreciation parties with free food or prizes to attract new customers or get old customers back into the store. All subprime lenders do not engage in predatory practices, but because such practices are most often associated with subprime mortgage, payday, title, pawnshop and refund anticipation lenders, it pays to understand how they work. Each type of lender has its unique practices and its own set of rules or regulations. 5
Payday Lending Payday loans give consumers cash until their next payday. A borrower writes a personal check to a payday lender, who holds the check for a period of 14 to 31 days. The check is more than the amount of cash that the borrower gets. It is quite common for a borrower to write a $115 check dated two weeks in the future to receive $100 in cash. At the end of the 14 to 31-day period, the lender cashes the borrower s check. If desired, the borrower returns with cash to reclaim the check or to renew the loan for additional fees. If you took a cross country family vacation, could you eat at a McDonald s restaurant all along Title Lending Consumers can get quick cash through car title loans if they are willing to use their car as collateral. Title loans typically are due after 30 days. The lender holds the borrower s car title until the loan is paid in full. After 30 days, the loan gets paid, usually in one lump sum. It can be renewed for another 30-day cycle. If it goes into default, the lender has the car repossessed. Missouri had about 230 title lenders in 2004. The annual percentage rate of interest for many car title loans is over 300%. The minimum title loan term is 30 days. On average, Missouri title lenders renew loans 3.5 times more often than they make new loans, keeping some borrowers caught in a cycle of debt. 17 There are an estimated 15,000 title lenders in the U.S. 18 On average nationwide, lenders loan 55% of the value of the vehicle to which they hold title. The median annual cost computed by Consumer Federation of America and based on the quoted monthly rate, was 300% APR and the mean APR was 294.25%. 19 Rent-to-Own Lending the way if you wanted to, since there are so many? Probably. It is sobering that there are even more payday loan stores in this country than there are McDonald s restaurants. By the end of 2004, there were about 13,600 McDonald s in the U.S. By the end of 2003, there were more than 22,000 payday loans stores. 15 In 2004, in Missouri alone, there were approximately 1,100 payday loan offices operating, which was a 37.5% increase over the previous year. 16 Rent-to-own agreements allow consumers to rent goods, for a weekly, bi-weekly or monthly fee. After the consumer fulfills the terms of the contract and makes payments for an agreed-upon time period, the consumer owns the item rented. If the contract is not completed the store picks up the rented item, and the consumer fees are not returned. Extra fees are charged if there is a lapse in payment and the contract is reinstated. How would you like to pay $2,200 for a television worth $500? That is not uncommon at many rent-to-own stores. The rent-to-own industry has little regulation. To own an item, renters often must pay several times the retail price of that same item. It is difficult for many borrowers to fully understand terms of their agreement. Advertising often mentions weekly payments, no credit check, no deposit and free delivery. Ads do not focus on what you would spend if you were to buy items outright elsewhere. 6 Poverty at Issue Fall/Winter 2005, Curators of the University of Missouri
Pawn Shop Lending Pawn shop loans give consumers short-term cash if they are willing to sell (or pawn) an item to a pawnbroker for possible repurchase by a specific date at a prearranged fixed price. The goods they pledge serve as security or collateral for a loan. If the borrower does not pay off the loan within the agreed upon time period, the goods are lost and the pawnbroker resells them and keeps the money. The interest rate that a pawnbroker may charge for a secured loan cannot exceed 2% per month (about 24% APR). 20 Because pawnbrokers may also charge for the storage and security of pawned property, actual annual percentage rates of interest can be quite high, when both interest and storage costs are taken into account. Subprime Mortgage Lending A subprime mortgage is offered to borrowers with less than perfect credit. In order to compensate for the risk of lending money to a borrower who has a low credit rating, the financial institution charges a higher interest rate. A subprime mortgage can be to refinance a home or a regular mortgage to purchase a house. Refund Anticipation Loan Quick tax loans, or refund anticipation loans (RALs) are offered to taxpayers who are in a hurry to get a tax refund. After going to a paid tax preparer to get a tax return filled out and filed electronically, taxpayers can borrow the value of the anticipated refund immediately. When the refund check comes back from the Internal Revenue Service (IRS), it is reduced by the amount of the refund anticipation loan. In 2004, according to a report issued by the Consumer Federation of America and the National Consumer Law Center, a RAL for the average refund of $2,150 bears an annual percentage rate (APR) of 178%. When preparation and administrative fees are included, the APRs for RALs can range from 70% to over 1800%. 22 In 2002, 75% of subprime mortgages were actually refinances of existing mortgages. Unfortunately for borrowers, nearly half of those who have subprime loans could have qualified for prime loans. Prime loan fees average about 1% of the loan, but subprime loan fees are often 5% or more. According to the Center for Responsible Lending, Americans lose an estimated $9.1 billion each year in predatory mortgage lending costs. 21 Poverty at Issue Fall/Winter 2005, Curators of the University of Missouri 7
Personal Stories One Payday Loan Borrower s Experience Bailey s Story Personal stories help us fully appreciate the impact of predatory lending on families and also help us begin to understand why regulation is ineffective in preventing abuses. Bailey s story is an example of what can go wrong when an uninformed, underpaid and financially strapped consumer enters the world of payday lending. This is her story according to Bailey. Bailey works full-time as an office manager, and she enjoys her work. She is 27 years old. She lives with her husband, and they are raising two sons and a daughter in a small town in Missouri. It has not been easy for her to get to this point in her life. At the time, it was such a quick fix to paying my bills and getting the things I needed to survive, she says. Bailey s problems really started when she was about 18. She took on the responsibility of paying for her own education. Even though she had little income and no credit history, she got several credit card offers and decided to apply for two major credit cards. She charged the limit of $500 on each card, but after she was unable to make the payments, over-the-limit and late fees pushed the balance of both cards up to thousands of dollars. When she slacked off in school and quit taking college seriously, she stopped getting the scholarships she d had to help pay the way. Because she was already in debt on her credit cards, she found herself in deep financial trouble. She took on a job as a waitress to get herself through. She let other things in her life take priority at times. She skipped classes sometimes or dropped out halfway through the semester. Living in a cycle of debt was difficult. About five years ago, Bailey started taking a serious look at her life. I realized that I could be doing so much better and that I should be doing much better, she says. She moved back home a little older and a little wiser after being away for five years. That was depressing, says Bailey, but I needed to start saving money to go back to school and to get back out on my own. There were times when I was going to another payday loan or cash advance place to get money to pay on the loans I already had, she says. She was working as a waitress, relying on a small hourly wage and tips. Her income was not always consistent. Bailey had taken out several payday loans to get by. She says that she didn t know how stupid it was then. 8 Poverty at Issue Fall/Winter 2005, Curators of the University of Missouri
I learned the hard way that borrowing on payday loans would actually create a more difficult situation, At the time, it was such a quick fix to paying my bills and getting the things I needed to survive, she says. It made her feel great that someone was willing to just trust her enough to give her cash on demand any time she had an unexpected expense. It almost became an addiction, though, says Bailey. There were times when I was going to another payday loan or cash advance place to get money to pay on the loans I already had, she says. Bailey did not want to risk getting her original check deposited and end up with a bad check to be prosecuted, so she would do what she had to by paying the minimum due or trying to pay off the loan. Sometimes I would actually pay more on a loan than what I had originally received, she says. When asked, Bailey said she did not even try to use a mainstream lender like a bank or a credit union. She said her credit history was not good because of late payments and balances on her past credit cards. Besides, going to a bank or credit union seemed like a complicated process to her, and payday loans seemed quicker and easier. I learned the hard way that borrowing on payday loans would actually create a more difficult situation, Bailey says. All the loans started to add up on me, and I started to worry about my situation at my bank. I did not want to get in any criminal trouble. I worried about having bad checks because I would not have enough money in my accounts to cover the post-dated checks I had written. I had to keep these payday loan companies from cashing my checks, so I kept paying them interest, she says. Her cycle of debt continued. The payday loan situation was something that Bailey had not told anyone in her family about. She was embarrassed and disappointed in herself that she had gotten into the mess she found herself in. Eventually, the situation escalated, and Bailey couldn t keep up. She had considered herself to be responsible and had a reputation within the family of being responsible. It was very hard for her, but she finally went to a family member for help. She felt she had no other option. Bailey says, I was luckier than some in these situations, though. I had family to help me out. Some people don t. The family member lent her money to pay off her loans, and a great burden was lifted. In spite of her struggles, Bailey continued to chip away at her education. She got an associate s degree at a community college where she lives. Then she transferred to a four-year university and received her bachelor s in Juvenile Justice. She graduated with honors. Poverty at Issue Fall/Winter 2005, Curators of the University of Missouri 9
Bailey says that she has definitely learned her lesson. She will never use a payday loan or cash advance again. When asked what she wished everyone could understand about being in her situation, Bailey says, I want everyone to understand that payday loans and cash advance places may be a quick fix to problems in your life--which is one way some of these places advertise--but in the long run your problem just gets bigger. You as the consumer lose in several ways. These companies win. You as the consumer lose in several ways. These companies win. Why? Bailey says that consumers either continue the loans indefinitely, paying more in interest than what they borrowed in the first place, or they jeopardize their financial situation by letting the checks get deposited, resulting in return check fees or worse - prosecution for bad checks. The company s win in this situation is greater than any money they will ever let you borrow!! Sources 1 Center for Responsible Lending Website, A Resource for Financial Lending Opponents, http://www.responsiblelending.org/. 2 40 hours per week x 52 weeks = 2080 hours per year 2005 poverty threshold for family of 3 = $16,090 per year $16090 / 2080 = approximately $7.74 per hour 3 Newman, Becca. A Basic Need Budget for Rural Missouri Single Mothers: Estimation and Comparison with Poverty Measures, http://extension.missouri. edu/cfe/poverty/basicneed.htm and Center for Responsible Wealth, a Project of United for a Fair Economy, Business Leaders and Investors for a Living Wage, http://www.responsiblewealth.org/living_wage/. 4 New Step Debt Consolidation Website, Statistics, http://www.newstepsolutions. com/debt-statistics.htm. 5 Perozek, M.G and Reinsdor, M.B. Alternative Measures of Personal Saving, April 2002, Bureau of Economic Analysis Website, http://www.bea.gov/bea/ ARTICLES/2002/04April/0402PersonalSaving.pdf. 6 U.S. Courts Website, Bankruptcy Statistics, http://www.uscourts.gov/bnkrpctystats/ statistics.htm#calendar. 7 Morgan Quitno Website, Personal Bankruptcy Rate in 2004, http://www. morganquitno.com/sr05sam1.pdf. 8 Barr, Michael S. Banking the Poor, Yale Journal on Regulation, 2004. 9 Center for Responsible Lending Website, A Resource for Financial Lending Opponents, http://www.responsiblelending.org/. 10 Center for Responsible Lending Website; The Ten Warning Signs of Predatory Lending, www.stopmortgagefraud.com; and Freddie Mac Website, How to Avoid Predatory Lending, http://www.freddiemac.com/corporate/buyown/english/ mortgages/lenders/avoiding_predlend.html; and Squires, G. Why the Poor Pay More. Praeger Publishers, Westport, CT, 2004. 11 Missouri Division of Finance, Survey of Payday Lenders, Report to the General Assembly, January 2005, http://www.missouri-finance.org/pdfs/survey.pdf. 12 Ibid. 13 Center for Responsible Lending Website, http://www.responsiblelending.org/. 14 Center for Responsible Lending Website, http://www.responsiblelending.org/. 15 News for McDonald's Franchisees http://www.licenseenews.com/news/news309. html; and Payday Lending Basics, Center for Responsible Lending Website, http://www.responsiblelending.org/payday/faq.cfm. 16 Missouri Division of Finance Website, Survey of Payday Lenders, Report to the General Assembly, January 2005, http://www.missouri-finance.org/pdfs/survey. pdf. 17 Ibid. 18 Bankrate.com Website (December 1, 2005). Arnold, K. Car title lending: Shortterm fix with long-term expense, http://www.bankrate.com/brm/news/auto/ 20051118a1.asp. 19 Fox, Jean Ann and Guy, E. Driven into Debt: CFA Car Title Loan Store and Online Survey, Consumer Federation of America, 2005, http://www.consumerfed.org/ pdfs/car_title_loan_report_111705.pdf. 20 Missouri Division of Finance Website. 21 Center for Responsible Lending Website, http://www.responsiblelending.org/. 22 Wu, Chi Chi & Fox, Jean Ann, contributing author, Refund Anticipation Loans: Updated Facts & Figures, NCLC/CFA, National Consumer Law Center, January 2006. http://www.consumerlaw.org/news/content/2006ral_early%20info.pdf. 10 Poverty at Issue Fall/Winter 2005, Curators of the University of Missouri