The Payday Advance Transaction
Payday advances are short-term, small, single-payment loans. The customer here writes a personal check for the borrowed amount of money plus the finance charges. The loan company then agrees in writing to present the check after the client’s next payday, which typically can be anything between 10 and 30 days.
The customer can redeem this check by paying off the loan and finance charges at the payday, or the loan company can cash this check. In a few states, clients can extend the term of such advance by paying just the finance charges. A new check has to be written.
Loan Size and Finance Charges
Payday loans and advances are usually between $100 and $500. However in some states, advances up to $1000 can be made. Finance charges range between $15 and $20 for each $100 of the amount loaned.
The Underwriting Process
The underwriting process is extremely streamlined with the payday loan companies. An applicant’s income and bank account is verified. Loan companies request that applicants should provide the last bank statement, identification such as driving license and social security number, residence proof, and last pay stub.
The final loan amount offered is usually limited to a percentage of the take-home pay. Credit bureau reports are not asked for. However there are some companies that seek information on the applicant’s present payday loan use.
A postdated check brings down the collection cost. If the client doesn’t redeem the check, then the company can collect the money cost effectively. The lender deposits the check to recover the loan amount and finance charges. However the customer must still have sufficient money in the bank account.
Costs
Consumer lending costs are classified into many categories – taxes, operating cost, and return on the capital invested.
Operating cost is the largest category, as it’s the basic work all creditors must do for extending credit. This includes the cost of acquisition, processing, office expenses, salaries, payment collection expenses, and the cost for bad credit.
Loan acquisition expense is on top of this list. This is followed by payment processing, and collecting past dues.
The cost for loan acquisition includes expenses for taking applications, evaluating them, loan document preparation cost, and the cost of money disbursement. The processing costs are receiving and recording payments, monitoring the account to make sure that the payment is prompt, and contacting clients with past due to collect late payments.
Regulatory Environment
Payday advance loans are regulated by federal and state laws. Plus, there are many lending agencies that ensure self-regulation voluntarily, adhering to industry standards as recommended by the Community Financial Services Association of America.
State Laws
Many states in the US, and District of Columbia allow payday loans with guidelines.
24 of these states have regulations and legislation that explicitly allow payday loans. Typically, state laws have exempted the lenders from any usury or interest rate ceilings in exchange for establishing maximum fees and rollover limits. However, state laws require licensing as well as periodic examinations for making sure that the companies are not violating any state or federal law.
17 states have prohibited payday loans by imposing strict interest rate ceilings, thus making these small loans unprofitable.
For instance, Alaska, Alabama, Virginia, and Rhode Island all have a 36% annual interest rate ceiling on these loans. Creditors here can charge a max of $2.77 on a $200 advance for 2 weeks. This amount is lower considerably than the $30-$45 payday lenders can charge in other states that allow such advances for the same product.
Non-price elements are also regulated by state laws. For instance, there are limitations on the number of times a loan can be rolled over or refinanced. 18 states, including Kansas, Florida and Colorado among others don’t allow customers to retire one advance with proceeds from a new payday loan. 5 states like Illinois and Idaho among others allow the present advance to be rolled over for a maximum of three times.
There are laws to limit the size of the loan too, usually between $300 and $500 for each advance. Some states do this directly, while others limit a check’s size, which includes both the finance charges and the loan amount.
Montana is an exception. Here, the loan amount is restricted to $300 or 25% of the client’s monthly income, whichever is less. Nevada too limits it to 33% of the monthly pay. These limitations are intended to stop consumers from falling too much into debt.
State laws do not allow payday firms from intimidating or forcing defaulting clients. Nevada disallows a lender from harassing clients by posting an NSF check publicly, or publishing a client list with bad checks.
However, some states allow criminal prosecution for fraud. For instance, Hawaii allows the initiation of criminal prosecution if a client stops payment or closes the bank account before repaying.
State laws also require payday companies to submit reports periodically, and submit themselves to on-site examinations. This enforces compliance, and protects consumers as well. Companies that are not willing to satisfy regulatory standards are driven out.
Federal Laws
Payday advances are subject to the Federal Truth in Lending Act, implemented by the Federal Reserve Board’s Regulation Z.
Truth in Lending requires detailed disclosures about all terms of transaction including the price. The price disclosure includes finance charges and the yearly percentage rate. Other disclosures include the loan amount, payment totals, and schedule of payments.
The Fair Debt Collection Practices Act has established debt-collection regulations for third-party collectors. There cannot be any false statements, harassment, or any undue pressure tactics for collecting debts. Most payday lenders however don’t use these collection services, as the small amounts involved makes this uneconomical.
The Community Financial Services Association of America also has a guideline on how collections from debtors can be made.
Self-Regulation
An industry trade association was set up by many payday loan companies in 1999. This is the Community Financial Services Association of America. Presently, the association has more than 60 members companies that run about 5000 offices across the country. This is about half of the total number of payday offices.
The main job of the Community Financial Services Association is to promote favorable regulatory environment the industry and promote industry standards. The association wants to ensure non-prohibitive price regulation, and supports the industry “best practices”, which include the following:
- Full disclosure of the yearly percentage rate, finance charges, and all terms and conditions of the transaction.
- Commitment for truthful and clear advertising.
- Complete compliance with all federal and state laws.
- Promoting consumer education on the loan services, and availability of credit counseling.
- Limiting the number of rollovers to 4 or the state’s maximum. Prohibiting where these rollovers are disallowed.
- Adhering to collection practice limitations as dictated by the Fair Debt Collection Practices Act.
- Provisioning a client’s right to rescind a transaction without any cost.
- Renunciation of threat or using criminal prosecution for collections.
- Self-policing the payday advance industry.
- Support legislation that incorporate association’s standards.
- Assurances that national banks follow association standards when the payday loan is extended because of an agreement with the bank.
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