We're only one month into 2007, and already, 19 states have introduced more than 50 separate pieces of legislation regulating the payday loan industry. While some of the current bills are holdovers from last year, state legislators are well on their way toward matching the 65 separate bills introduced last year in 25 states.
You can perhaps understand the traditional animosity toward alcohol and tobacco companies. But payday lenders provide a much-needed service to a large swath of the public that has been completely abandoned by traditional financial institutions.
A short-term bridge over troubled water
Payday loans, as its name suggests, are short-term loans to consumers who, for whatever reason, run short of cash and need money only until they get paid again. Typically, loans are for less than $1,000 and run for about two weeks, though they can be extended to as long as 30 days in some cases. Customers write a post-dated check for the amount of the loan, plus the interest to be paid, which can then be deposited by the lender at the end of the loan period. But that interest or fee has critics contending that Tony Soprano is actually running the lenders' operations.
Credit counselors charge that the interest is usurious. For example, Advance America (NYSE: AEA ) charges $15 on a 14-day $100 loan; extended out to a year, that's an annual percentage rate of 391%. The typical annual percentage rate for a loan from a Dollar Financial (Nasdaq: DLLR ) Money Mart store is 456%, while Cash America's (NYSE: CSH ) $25 fee per $100 borrowed would be equivalent to a 651% APR. To fiscally prudent people, this is not only outrageous, but predatory.
Yet such arguments distort the nature of these loans. Many of the people who use these services are considered a credit risk by banks, credit unions, and other financial institutions. Those businesses wouldn't even give these people a bridge loan, let alone charge a rate that wouldn't be considered usurious. These consumers have become what is known as the "unbanked" or "underbanked." In fact, they may not even have poor credit histories -- they simply don't have any at all.
Serving the underserved
For a variety of reasons, many of these consumers lack checking or savings accounts, and cannot obtain credit card cash advances. Many payday loan customers are recent immigrants. EZCORP (Nasdaq: EZPW ) , for example, is based primarily in and around Texas, and has found that many of its customers are Mexican immigrants. Because the use of payday services in Mexico is not as stigmatized as it is here, it's even more of a growing business south of the border, and EZCORP has expansion plans there.
While payday loans are the bread and butter of these businesses, they're often not the sole source of revenue. These lenders often cater to the full range of the underbanked consumer's needs, and many also operate pawnshops, where merchandise is put up as collateral for a small, short-term loan. Some also provide low-limit credit cards and buy-here/pay-here auto dealers. While Advance America is unique in that it only provides payday loans, CompuCredit (Nasdaq: CCRT ) primarily offers consumers Visa and MasterCard credit cards with an average limit of about $1,000, in addition to its smaller payday loan operation. It also runs a string of car dealers, as does First Cash Financial (Nasdaq: FCFS ) .
Defaulting on service providers
The payday loan industry remains under assault at both the federal and state level. Sweeping changes in FDIC regulations regarding payday loans forced many lenders to adjust their business models. States have responded in kind, and even today, you can't get a payday loan in a dozen states.
A few of the bills that have been introduced could actually expand the market into states where payday loans are currently not permitted -- New Jersey legislation, for example, would allow a maximum of $500 to be loaned for no more than 30 days at fees limited to 10% of the total. Most, however, seek to restrict or severely limit payday lending in their jurisdictions. One bill in Louisiana wants to outlaw the practice altogether.
Foolish final thoughts
The Foolish way to handle your finances is to live below your means, or at least within them, preventing the need for a payday loan. But many consumers can't get access to traditional sources of money, and have needs unmet by most financial institutions.
Not everyone using payday loans is poor or a credit risk. The typical Texas customer using EZCORP's maximum $1,500 payday loan service had an individual annual income between $60,000 and $70,000. Dollar Financial has found that 60% of its Canadian customers and 80% of its U.K. customers have bank accounts, while only 38% of its U.S. clients do.
Yet for impoverished customers, or those with bad credit, some of these businesses' ancillary services can help restore good credit standing. There's certainly no reason to hold your nose when you invest in these companies; despite the various regulatory hurdles they face, they're profitable and growing. In my book, any company helping the public by addressing a currently unmet need should be considered virtuous.
Brush up on your payday lenders with these Foolish articles: