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Legal and Ethical Issues Concerning Payday

Loans

I. Introduction

II. Ethics of Payday Loans

III. Legal issues around Payday Loans

IV. Summary

There has been a great amount of deliberation regarding

the ethics and business practices of payday loan companies. On one

side, the opponents of the payday lending practice argue that the high

interest rates, shady collection methods, and the unseen snares of

long-term payment arrangement scenarios lead to large, often times

astronomical, final payoff amounts for what would otherwise be a

relatively small loan amount. However, you also have the payday loan

service providers and industry proponents that bring valid arguments to

support their views that payday loans provide valuable, important services to

a particular sector of society that would otherwise have no chance of

obtaining funds, in moments of dire economic needs. Payday loan providers

have argued that the practice of charging higher interest rates are a

necessity to counter the amount of risk they are undertaking by providing

unsecured loans to those individuals with a questionable credit history.

These individuals (payday lenders) also argue that payday loans bring a

balance to business of lending funds, because the traditional lending


practices unfairly rule out those individuals who are frequently in need of the

funding the most.

The basic premise behind the payday loans business is that they offer

short-term loans, intended to be used for critical emergencies usually

because the individual in need has no other immediate lending sources

are available. The individuals that usually apply for payday loans are

people that have a poor to less-than-average credit history, or have

difficulty with securing other immediate financing, through the

traditional lending practices.

To this extent, the payday loan companies do provide a valuable

service to those who truly need them by offering immediate financing

to a certain segment of the population who would otherwise have no

options available.

The Ethical Issue of Payday Loans

What terms would you be willing to agree to, if you needed to obtain

emergency funds for say unexpected auto repairs or to repair your

furnace, in the dead of winter, maybe 300% interest for a $500 loan?

Generally we would like to think, or at least hope, that your average

person would say “no thank you”. Surprisingly, there are many of our

neighbors saying “yes”. The industry of payday loans (or also known

as cash advances) has seen a growth of borrowers with needs, whether

from bills or holiday shopping, for small amounts of money and these
people are willing to agree to outrageous terms. Usually, these people

have scenarios where their payday has just past, they do not maintain

any type of savings account, their credit history is less then perfect

and due to their credit history they are unable to secure a credit card

either. Now enter the payday lender that is offering to provide a

solution. The payday lender lets the borrower write them a check for a

certain amount (usually $100 to $1000 depending on state laws), and

the borrower will get an immediate sum of cash. The payday lender

withholds an amount for the fee of the loan, which is included in the

original amount of the check. The payday lender will then give the

loan for two (2) weeks or until the borrowers next payday. After two

weeks the borrower has several options available to them in order to

satisfy the payday loan. The borrower can do nothing and allow the

payday lender to deposit the previously written check for payment, or

that individual may pay, the payday lender, a cash amount equivalent

to the original check. A third option is also available and this is where

the payday loan practices start down a path that many believe is

predatory in nature. The borrower may chose to provide the payday

lender, with another check and extend the loan or just pay the finance

charge to roll the loan over for another pay period. Since a majority of

borrowers actually do end up extending their original loan this single

issue has become the primary case for the negative views on the

payday loan industry. This allows the person to extend the loan over
and over but the initial fee for the loan is just charged each time. The

issue is that when a person extends a loan over and over the fees

initially incurred are charged again, with each extension. Over the

course of a year a person could accrue an enormous amount in fees

alone, and this doesn’t even take into account the extremely high

interest rate. “Loans typically cost 400% annual interest (APR) or

more. The finance charge ranges from $15 to $30 to borrow $100. For

two-week loans, these finance charges result in interest rates from 390

to 780% APR. Shorter term loans have even higher APRs.”1

The main pitfall with payday loans is that they do not provide a

solution to the real problem for many of these people. If these

individuals are already struggling with financial adversity, then the

payday loans are only going to make the problem worse. There is a

common belief shared among many of those that opposed the payday

loan practice that the industry seeks to prey on the financially

uneducated. As most of the potential borrowers overlook the associate

risk in accepting these loans and can only see the small fee for the

loan and/or the fact the company will just hold the check.

The industry of payday loans has prospered by successful marketing

itself as a quick fix or “short-term relief for a cash crunch” but in reality

they are “designed to catch working people – or those with a steady

source of income such as Social Security or a disability check – in a


1
Payday Loan Terms, http://www.paydayloaninfo.org/facts.asp
long-term debt trap.”2 This is highly evident since the terms of these

loans are normally such that the people have no way to pay back the

loan, when it is due, without destroying their already limited or fixed

budget. Thus unfolds the devastating trap these people became

snared in as they are forced to immediately take out a new loan after

paying the first one back or extending the original loan (incurring

additional fees).

The payday loan industry has not shied away from justifying their

services. They have argued that their payday loan services can be less

expensive than bounced check fees and overdraft protection

programs, by traditional banking institutions. As well as contending

that payday loans are the quickest and simplest manner for some

people to get necessary funds. However, there have been several

studies that have negated these statements. For instance, the

Consumer Federation of America compiled the following findings based

off of studies performed by various educational institutions:

1. “Payday loan borrowers are worse off than consumers who have no

access to payday loans.”

2. “Using payday loans causes financial hardship for families.”

3. “Payday loans have a fifty-fifty chance of causing defaults in the first

year of use.”

2
Payday Loans Put Families in the Red, Center for Responsible Lending, February 20,
2009
4. “Using payday loans causes borrowers to file for bankruptcy.”3

We noted earlier that the payday industry has a target audience of

lower income, financially uneducated individuals but it also has

unfortunately taken a grave effect on those individuals who are serving

in our armed forces. We are all aware that serving in the military is not

going to shower abundant wealth on anyone, and that many of these

individuals with families have difficulty making ends-meat but for a

long period of time it was unnoticed that these families were becoming

victims of these lending schemes until the Pentagon reported that

these predatory practices were weakening our military, because debt

issues were threatening the security clearances of military personnel.

This brought about the federal government implementing laws to

assist in protecting military families from the payday lending traps

through the Military Lending Act, since then States have also began

looking into the legal status of these practices and the negative

economic impact on the communities.

The Legal Issues of Payday Loans

Since the basic function of law is to provide rules that govern our

society as well as to allow the individuals governed by those laws to

live in a safe and pleasant environment, and to have their lives and

possessions be given consideration and respect by other members of a

3
Research Findings Illustrate the High Risk of High-Cost Short-Term Loans for
Consumers, Compiled by Jean Ann Fox, Consumer Federation of America, February
18, 2009
society. Then we would expect that an industry such as that of the

payday loan would be drawing the attention of both federal and state

legislative members, looking to protect the residents being caught in

the traps of quick fix financing operations.

Across the country debates and argument play back and forth between

the payday loan industry and growing number of citizen groups, who

are taking a stance in opposition predatory lending practices plaguing

their communities. The laws in particular that are applicable to this

situation are known as Usury laws. Usury is defined as the act of

lending money at an unreasonably high interest rate or “taking of more

than the law allows on a loan or for forbearance of a debt.” 4


Other

than protecting military families with a “36% APR cap on small

predatory loans” 5 the federal government has yet to move to expand

legal reforms across the country, which has allowed some big national

banks to get into the short term loan business with lending products

that are virtually similar to the payday loans found at neighborhood

locations across the country (i.e.; Cash American, Payday Loans, etc).

In the absence of the of the federal government enforcing legislation to

curb the use of the tactics employee by the payday lending industry,

4
Business Law, The Ethical, Global, and E-Commerce Environment- Mallor, Barnes,
Bowers & Langvardt, 4th Edition
5
Military Lending Act to take effect October 1 , September 27, 2007,
http://www.consumerfed.org
several states have enacted usury laws to limit the maximum amount

of loans and/or fees and financing charges.

To date, fifteen different states, plus the District of Columbia, have

made it illegal to charge triple-digit interest. In addition, two states

(Ohio and Arizona) held ballot measures this past fall/winter on the

topic of high interest rates charged on loans. Arizona became the

sixteenth state to put a stop to the predatory lending through an

interest rate cap which took effect as of July 2010. Many of the

changes made on the state level have made an effort to limit the risk

associated with the payday loan practices but in all there are thirty-

four states which still authorize high-cost lending.

While regulation varies from state to state, there seems to be a fairly

common framework on which these laws have been established.

Reviewing the current payday lending states statues you can see the

commonality, the maximum loan amount range from $100 – 1000 with

the majority of states establishing a $500 maximum. In addition, many

have made an attempt at controlling the interest amounts as well

through various limitation and calculation methods.

The State laws regulating payday loans have also established

guidelines as to what lenders must disclose to borrowers. Prior to

enacted legislation of the short-term loan laws; payday lenders were

allowed to hide their fees in lengthy cash advance loan agreements

that were written in very vague language. These lenders are now
required to provide agreements written in a clear, understandable

manner and that discloses fees upfront in bold typeface print.

Now with the expansion of the internet into practically every aspect of

our lives and business, a new door has been opened up to the payday

lending institution by allowing borrowers to apply online or through

faxed application forms. Loans are now direct deposited into a

borrower's bank account and then electronically withdrawn on the next

payday. In addition, most internet payday loan agreements are

structured to automatically renew every payday, with finance charges

electronically withdrawn from the borrower's bank account.

So, even though states either have or are working to enacted laws to

curtail the actions of the payday loan industry and protect the

consumer, these laws have seemed to miss the a major concern, of

payday loans, by failing to limit the number of times an individual may

roll over or extend a loan.

Bringing it all together

It seems that society expects the government to protect us all, the

consumer, from practices, such as payday lending, by enacting legal

measures or laws that would prevent an organization from taking

advantage of certain people. However, we also live in a capitalistic

society where if there is a demand someone is going to provide the

“supply” in hopes of making a buck or two. Unfortunately, we do live

in a money driven-get it now type of society which has set many


people up for failure. Every day you see a new gadget or gizmo come

out or lately we see the cost of everything from food to fuel on the rise.

The average working person’s pay has not risen like the price of gas,

sales tax, or even milk and many have lost their job all together. So

people do what they feel they must do in order to keep up. Society

shows them that they can have it, but fails to show them what the cost

of having it entails. Peoples demand for things can out weigh any risks

associated with obtaining the means to satisfy that demand. This

mentality is what has helped to create this niche for the payday loan

industry. A demand for small short term loans was created and they

have filled it!!!

With that being said, it doesn’t mean that these organizations are not

to be held accountable. There is no questioning the fact that the

current practices can and often do leave individuals struggling to

satisfy the requirements of these loan agreements or in some cases

worse off than when they started.

While we can read about the many myths surrounding payday loans

and there are actual horror stories which do exist but when taken as a

whole the they are quite similar to other industries aimed at the

nation's lower wage earners (such as used car sales, high interest rate

credit cards, etc).

Personally, I feel that the use of these institutions should be a last

resort. There will always be emergencies that require special


circumstances. However, if we as society really want to help those

individuals who are being swept up in the payday loan schemes then

maybe we should look at educating these individuals about

alternatives such as:

• Build up an emergency cash fund in your savings account

• Build credit so you can borrow from mainstream lenders (in

moderation)

• Get a signature loan from your bank or credit union

• Negotiate a payment plan with your lenders (ask about loan

modification)

• Try peer to peer lending services for a better deal

At the end of the day, this heated debate is unlikely to end. We have

seen more states aim to pass stricter laws to help regulate the use of

payday loans and the practices of payday lenders. Views have been

expressed as well, on both sides of the issue. For the users of payday

loans, it seems to be a love-hate relationship, but the overriding factor

here is that the decision is ultimately theirs!


Cited Sources:

1.Mallor, J.P., Barnes, J.A., Bowers, T, & Langvardt A.W., Business Law,

The Ethical, Global, and E-Commerce Environment; Irwin McGraw-Hill,

14th Ed., 2010

2. Baylor, Don, The Hidden Cost of Payday Lending, Texas Business

Review, April 2008

3. Military Lending Act to take effect October 1 , September 27, 2007.

Retrieved July 6, 2010 from http://www.consumerfed.org


4. Research Findings Illustrate the High Risk of High-Cost Short-Term Loans

for Consumers, Compiled by Jean Ann Fox, Consumer Federation of America,

February 18, 2009

5. Payday Loans Put Families in the Red, Center for Responsible Lending,

February 20, 2009

6.Payday Loan Terms, http://www.paydayloaninfo.org/facts.asp.


Retrieved July 12, 2010

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