Consumer Credit Reform: Payday Lending declines 84 percent in Virginia, but most shift to Car Title Lending

Reading the Dena Potter's (no relation to Harry Potter) article in the Virginian Pilot brought a big smile to my face. I worked extensively on this issue over the last several years and without a doubt, Payday Lending is one of the worst types of businesses out there. Cloaked in the veil of helping poor people out, people that are in a financial bind that don't have access to quick cash to get you over the rough spots, these guys are beating it out of town. Why?

When this business was authorized to be exempt from the state's usury laws (which have been around since Colonial Virginia) in 2002, they were able to charge Annual Interest Rates in excess of 36%. On a one week loan, lenders charged $15 for every $100 borrowed for a maximum of $500 per borrowed week. This ends up being an additional $75 on top of the $500 borrowed, if a person takes the maximum. Most people that are in this situation can't pay off a $575 loan in one week, so the Payday Lenders suggest that if this happens they can just get a new one week loan to pay off what they couldn't pay. Thus beginning the cycle of debt that is almost impossible to escape.

The average Payday Loan borrower took out between 10 to 13 loans in a year which quickly adds up to an APR of close to 400%. This is what is called "Compounding Interest." Compounding Interest is good if you are investing money. But if you are borrowing money with compounding interest, you will quickly find that the original amount, or the principle, has been rapidly exceeded by the interest rate. In the case of Payday Loans, the $15 per every $100 borrowed has been "rolled over" several times to where a borrower isn't paying back the principle any more, but the compounding interest generated from the repeat borrowing. The financial hole that has been dug is deep.

From 2002 to 2006, Payday Lending stores expanded so rapidly that there were twice as many Payday Lending storefronts in Virginia than where McDonald's. Three times more than Starbucks. That's a lot and speaks volumes to the need for small dollar short term loans. But the question became, do these loans need to be based off compounding interest so that a borrower is likely to become trapped in the loans? Payday Lenders got a foothold in Virginia and fought hard against interest rate caps or any restrictions.

From the 2006 through 2009 General Assembly session, grassroots and consumer protection groups fought for interest rate caps and restrictions to reign-in Payday Lending, and won some major reforms. A 36% interest rate cap was included in compromise legislation, along with limiting the number of loans a borrower can take out in a six month period as well as doubling the repayment period based off the borrower's pay period. The Payday Lending industry was able to get additional fees included that negated the 36% interest rate cap. The the Payday Lending industry found a loophole that allowed for open-ended lines of credit based off of credit card billing period, in order to get around the compromise legislation and started shifting to more lucrative Car Title Lending.

The Virginia General Assembly closed this last loophole for Payday Lenders, but did not address the Car Title Lending industry. Instead, they were given a warning that they were next and they needed to figure out a fair way of doing their business. Car Title Lending operates pretty much the same way, except they use a person's car as collateral. They treat the loans as open-ended lines of credit at twice the assessed value of the car. The problem with this is the car being used as collateral is actually a secured loan. The same grassroots and consumer protection groups fought to move the Car Title Lenders under the Virginia Consumer Finance Act which would address this aspect of Predatory Lending. They will have to take this up after the 2009 Virginia Statewide races and House of Delegates contests, but it is clear that the momentum is on the side of grassroots and consumer protection groups.