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Payday Industry in Danger of Default

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Take a look at these scoundrels! If you find yourself short of cash and need a quick advance of $500, they're going to charge you $50. While that might not sound particularly steep, that actually works out to an annual percentage rate of 260%! Worse, they're charging these usurious rates even though state laws limit interest charges to 36% or so.

Who are these dastards? Some nefarious payday lender like Advance America (NYSE: AEA  ) or First Cash Financial (Nasdaq: FCFS  ) ? Maybe they're a pawnshop operator like EZCORP (Nasdaq: EZPW  ) ?

Nah! It's none other than Wells Fargo (NYSE: WFC  ) , the bank that has been suckling at the teat of the taxpayer by taking $25 billion in loans from Treasury, scooping up the ragged remains of Wachovia (NYSE: WB  ) , and benefiting from the pain inflicted on the financial services industry.

This is significant because voters handed the payday industry significant setbacks in ballot initiatives in both Ohio and Arizona last week. Payday lender Cash America is being forced to close down 43 shops in Ohio because voters passed a cap on short-term loans at 28%. Yet, not only is Wells Fargo permitted to continue operating there, but it has official sanction because it's "regulated."

Wells Fargo offers a service called Direct Deposit Advance, which permits customers to borrow up to $500 ahead of their paycheck being deposited for a fee of $2 for every $20 advanced -- that works out to the 260% APR mentioned earlier. But don't look on Wells Fargo for that kind of disclosure as it will only be revealed after the borrower gets the loan and receives his bank statement. It's not common for major banks to offer payday loans, but Wells Fargo is not alone.

U.S. Bancorp (NYSE: USB  ) charges a similar amount as Wells Fargo does but says that the APR is 120%, presumably because they're looking at it as a monthly charge instead of a biweekly one. Fifth Third Bancorp (Nasdaq: FITB  ) charges $1 per $10 borrow through its Early Access program.

The much-maligned payday loan industry is actually far more egalitarian than their "regulated" brethren even though their risks of default are higher, which ought to justify the higher fees they charged. You don't need to have an account with a payday lender to get a cash advance like you do with Wells Fargo. And while payday lenders have limited means of forcing collections, Wells Fargo has any deposit over $100 automatically deducted from your account to pay themselves back.

The FDIC began a pilot program this year to have traditional financial institutions offer micro loans at interest rates that payday lenders have said are unprofitable. While thousands of loans have been made, it's not a runaway success because the banks are finding it hard to make money just as the payday industry has. One of the things not addressed in the pilot program, though, is providing loans to people with poor credit. Payday lenders do that every day; banks won't loan money to someone who has bad credit.

Because they have the imprimatur of the federal government, banks have the right to employ the same programs payday lenders are castigated for. Perhaps that explains why they've been so vociferous in their support of restrictions on payday lenders: They just don't want the competition.

First Cash Financial Services is a Motley Fool HG Pay Dirt recommendation. US Bancorp is a Motley Fool Income Investor selection. Try any of our Foolish newsletters today, free for 30 days.

Fool contributor Rich Duprey owns shares of EZCORP but does not have a financial position in any of the other stocks mentioned in this article. You can see his holdings here. The Motley Fool has a disclosure policy.

Read/Post Comments (13) | Recommend This Article (14)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 10, 2008, at 4:54 PM, 5krunner wrote:

    Regarding the bank programs, while the APR is high, they do have usage limitations.

    That is, a payday lender keeps you coming back -- forever.

    The banks listed above allow a certain number of transactions per period with a cooling off period, so the consumer doesn't get "hooked".

    Would you prefer the consumer to go to a pawn shop or get the service from their bank, where they will have adequate disclosures and protections.

  • Report this Comment On November 10, 2008, at 5:32 PM, GregFay wrote:

    5K runner or (High Ranking Bank Employee/Officer, not sure why you didn't use your real title??) ..... your statement is false. The banks do not any such limitations!! nor do they disclose the transaction as the article outlined. Nice try but you did not hide your real agenda.

  • Report this Comment On November 10, 2008, at 6:29 PM, 5krunner wrote:

    Correct, I'm a banker...although wrong, the statement isn't false.

    While we don't offer the product described above, banks MUST disclose APR and other pricing info prior to the consumer advancing on the loan. If that doesn't happen, the consumer should contact the OCC or whatever regulator oversees the bank.

    So the article above saying the consumer doesn't learn of the APR until their statement cuts, isn't correct. The consumer must receive disclosures before opting into the program.

    Side note...about how Wells automatically takes the $100 to repay the advance. Of course the consumer should be made of aware of the process, but what is so evil about the bank actually getting paid back?

  • Report this Comment On November 10, 2008, at 6:42 PM, blfish wrote:

    GregFay: Thanks for clarifying that 5krunner is wrong.

    5krunner: While payday lenders may invite their customers to return if they need to, the lenders intent is NOT to trap the customer into continuing to do loans. They cap the amount they loan the customer to 25% of net income (at least the honest places do.) I know this, I've worked in the payday loan industry for years). There are places that loan more than that, but not any place that is in a regulated state (like us, in Oregon, we CAN'T loan more than 25%). However, banks (like Wells Fargo) will loan up to the TOTAL amount of the customers direct deposit (less the fee) so, for example, if my direct deposit every 2 weeks is $1000.00, they will loan me up to $900.00 EVERY TWO WEEKS. How is that not trapping a person into doing loans again and again???

    In Oregon, we have a law that the customer has to wait 7 days before doing another payday loan after one is paid off. We live with it, because we have to, but banks don't have to follow that law.

    It seems to me that the banks are much more predatory than payday lenders are... At least here.

  • Report this Comment On November 10, 2008, at 6:58 PM, EXINE wrote:

    5krunner - It sounds as if you've been reading the inflammatory headlines rather than looking at the real story about payday loans. I have been in the payday loan industry for 20 years. Our customers are already bank or credit union customers, but they're doing business with us as well. They can compare the cost of late fees, overdraft fees and bounced check fees. Have you looked at the usage patterns of your typical overdraft customers? Studies I've seen show that the average overdraft customer accesses the overdraft protection more often than the average customer chooses a payday loan over like periods of time. Does your bank offer a no-fee payment if a customer tells you that they need additional time to repay the overdraft debt, or do you simply sweep their account when a deposit is made? Are your customers even aware when they overdraft their account, with a notification at the terminal or ATM? Payday lenders are in the business of giving customers more financial choices by competing with bank products. Perhaps it's the competition you'd like to get rid of in order to generate more bank fees. Payday loans can be a sound choice for short term credit and should be available to consumers from responsible lenders, whether the lender is a bank, credit union, or money services business.

  • Report this Comment On November 10, 2008, at 10:38 PM, JEM93 wrote:

    That is interesting that Banks have the right to charge whatever rates they want but payday lenders can't. I have been following this payday loan debate, and found a company that is going to offer peer-to-peer payday loans soon. They are called YadYap (payday backwards). If it works it is a great idea. There is not much information on their site right now but their blog has quite a bit.

  • Report this Comment On November 11, 2008, at 4:45 PM, cactushugger71 wrote:

    The banking industry is indeed in need of reform. The industry as a whole is in question, the global economic meltdown we are currently experiencing is evidence. I realize that the banking industry is strongly opposed to having legislation and voter initiatives decide interest rates and best practices. I have a simple solution. Return to the post 1930’s Depression Era of ethics and give consumers a fair deal.

    Some credit card programs, loans and mortgages have all the ethics of a shell game at Times Square. Of course there is bound to be call for reform. The industry has shown lately that it is not capable of self regulation. If that is indeed the case, government regulation will be forced to step in to insure economic stability, which is a shame because as you know that is a very inflexible way to do business. Yet it is unreasonable for Wall St. to continue to ask for carte blanche and the run to DC for taxpayer rescues because unscrupulous bankers and investors took reckless risk. Those types of actions invite legislative guidance in the form of regulation.

    However, to have the payday loan industry be like a child in the schoolyard pointing fingers saying, "they are bad so I can be really bad," is ridiculous. If the financial, banking and payday loan industries cannot maintain a basic level of ethics one will be provided for them…by the state.

  • Report this Comment On November 11, 2008, at 4:48 PM, sparagi wrote:

    It seems like the PDL industry did the heavy lifting in this one. They helped build the industry up and the demand and now banks want to get into the business.

    I'm shocked that this information was not made available to voters prior to the election? I think it would have made a difference. It's seems once banks start doing it, it becomes socially acceptable.

    You can read more about the PDL industry at my blog:

  • Report this Comment On November 13, 2008, at 5:09 AM, SynapticDatabase wrote:

    The banking industry is FILLED with high powered crooks who have the leverage to manipulate regulation and state laws. This is awful because in the states they have succeeded, its created a gap in a credit service that is widely needed. What is it replaced with? NSF fees that are going upwards of 6000% apr. Banking customers need to start understanding that a NSF fee is no more different than a interest charge on money loaned. Compare the rates between payday lending providers and banks and the cheaper option will ALWAYS be payday lending. And whats this garbage about deferred deposit services only servicing people with good credit??! Its like selling ice to an Eskimo. Ridiculous. Want to know more about the industry? Check out these links:

  • Report this Comment On November 14, 2008, at 3:20 PM, Banker1227 wrote:

    I actually had a nice long paragraph to add to this discussion but somehow I hit the back button and am too lazy to re-write some of the information. I would just like to respond to SynapticDatabase with a response and a thought. Yes, NSF and overdraft charges would fall into a catergory of an interest rate loan since they did not have the money and we are fronting it to them. In regards to the 6000% APR you would have to first factor in how much the item was and the fee for that item to mathematically figure out the APR. So please do not throw out large numbers like that as some readers would actually believe you; silly huh? Secondly, NSF/OD charges are needed and warranted because there are some people out there that fraudently will use the account and also people who do not pay back the bank after we graciously paid their mortgage, car loan, etc. without them having the money. Now if we do not get paid back who is the victim? We take calculated risks every single day. Sometimes they are for the best decisions and sometimes we come out wrong. Please remember that when we come to decisions we are humans after all, and if you want a bank that does not charge a fee, ask UNICEF to open up a bank.

  • Report this Comment On November 19, 2008, at 4:30 AM, SynapticDatabase wrote:

    Want to see how Bank NSF charges can come up to 6000% APR? Here are the numbers if you really want to look into them.

    Lets to make things easy, lets say a customer overdrafts their bank account by $100 dollars. Most people outside the payday lending industry would approximate the NSF fees at $35 dollars.

    1 single transaction amounting in a $100 overdraft, resulting in a NSF fee of $35 dollars. Makes sense right?

    What people outside the industry don't understand is the bank charges a NSF fee PER TRANSACTION after the bank goes negative. In a real life scenario, you never spend a $100 dollars you know you don't have. Instead, you spend it in increments of $5, $20, $10, etc - thinking you had the money in the bank all along.

    Now we're not talking about one NSF fee - we're talking about multiple NSF fees for a very small amount of principle loaned, for a VERY SHORT PERIOD OF TIME. But lets make things simple - lets say the person over drafted 3 times, on a one hundred dollar balance.

    A typical overdraft fee is $35 dollars. Lets ASSUME that the person will payback the overdraft and balance on the next paycheck. In this scenario, this person was just charged $105 dollars for taking out a balance of $100 dollars.

    To calculate simple APR interest we use this formula (only applicable when using it to calculate $100 principle balance):

    (daily interest amount) * 365 = APR

    (105/14) * 365 = 2737.5% APR

    2737.5% APR!!! This is assuming a LOT of conservative numbers. Its assuming that our bank customer will pay on the next paycheck. But because of the weekly charges that come into play (most banks charge you extra weekly when your bank account is in the negative - the charge is usually around $10 dollars) most customers pay the bank way before their next paychecks come into play. So lets take in the scenario that the customer pays the bank back after 5 days.

    (105/5) * 365 = 7665% APR!!

    There are so many factors we're not calculating that will make this number go out as far as 10,000% APR and higher. I'd show them to you but hey, this post is getting a little long already! ;)

  • Report this Comment On January 07, 2009, at 10:13 PM, jerjer77 wrote:

    There are a number of people here commenting on the supposed lack of disclosure by payday loan companies. It's obvious none of these folks have ever been in a payday loan store much less actually applied for and received a payday loan.

    I've been in the industry since 1997. 16 locations in 4 states.

    If one were to actually visit a payday loan location the first thing you would notice is the plethora of disclosures on the walls, on the pre-applications, on the applications, and on the contracts.

    No one walks out of a payday loan store NOT knowing what a payday loan will cost them!

    We are much better than banks at disclosing our fees, our payback expectations, consumer options and the ramifications of a consumer's failure to pay back our money.

  • Report this Comment On January 07, 2009, at 11:07 PM, jerjer77 wrote:

    There are a number of people here commenting on the supposed lack of disclosure by payday loan companies. It's obvious none of these folks have ever been in a payday loan store much less actually applied for and received a payday loan.

    I've been in the industry since 1997. 16 locations in 4 states.

    If one were to actually visit a payday loan location the first thing you would notice is the plethora of disclosures on the walls, on the pre-applications, on the applications, and on the contracts.

    No one walks out of a payday loan store NOT knowing what a payday loan will cost them!

    We are much better than banks at disclosing our fees, our payback expectations, consumer options and the ramifications of a consumer's failure to pay back our money.

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