Payday Loans and Tax Preparers    

 Each year, 12 million borrowers spend approximately $7.4 billion on payday loans.  But the payday lenders have come under growing scrutiny in recent years, as regulators and think tanks such as the Pew Charitable Trust consider the impact of such loans on low-income families. 

Pew has released a series of research reports on payday loans, focusing on who borrows, where they borrow, how they borrow and repay the loans, and Pew’s recommendations for change.  The newly-organized Consumer Financial Protection Bureau (CFPB) has dedicated a page to the topic. 

How is this of interest to independent tax preparers?  Preparers who invest in storefront locations often seek to diversify in order to generate revenue outside of tax season – offering a wide range of financial services that include tax preparation, money wire transfers, utility payments services, payday loans and vehicle title loans.  At present, 35 states permit storefront payday lending operations. 

What is a Payday Loan?

A payday loan – which might also be called a “cash advance” or “check loan” – is a short-term loan, generally for $500 or less, that is typically due on your next payday.

Payday loans generally have three features: 

• The loans are for small amounts.
• The loans typically come due your next payday.
• You must give lenders access to your checking account or write a check for the full balance in advance that the lender has an option of depositing when the loan comes due. 

Payday Loan Usage Statistics

In terms of usage, the Pew studies show that: 

• Pew’s survey found 5.5 percent of adults nationwide have used a payday loan in the past five years, with three-quarters of borrowers using storefront lenders and almost one-quarter borrowing online.
• State regulatory data show that borrowers take out eight payday loans a year, spending about $520 on interest with an average loan size of $375. Overall, 12 million Americans used a storefront or online payday loan in 2010, the most recent year for which substantial data are available.
• Most payday loan borrowers are white, female, and are 25 to 44 years old. However, after controlling for other characteristics, there are five groups that have higher odds of having used a payday loan: those without a four-year college degree; home renters; African Americans; those earning below $40,000 annually; and those who are separated or divorced.
• It is notable that, while lower income is associated with a higher likelihood of payday loan usage, other factors can be more predictive of payday borrowing than income. For example, low-income homeowners are less prone to usage than higher-income renters: 8 percent of renters earning $40,000 to $100,000 have used payday loans, compared with 6 percent of homeowners earning $15,000 up to $40,000. 

Much of the attention being given payday lenders is an indictment of the annualized loan rates offered, which vary from a low of 129 percent in Colorado to a high of 582 percent in Idaho.

Defending the Payday Loan

While the Pew reports provide useful insights, some would argue that not all of their policy recommendations – which largely reflect only the interests of borrowers – are consistent with a free and independent marketplace.  In addition, the following have been cited in arguments that favor the payday loan system: 

• Payday loans assist low-income families in avoiding service shutoffs, evictions and other disruptive events, and may assist in making food available for themselves and their families.
• The interest rates charged do not reflect absolute dollar returns for the lender, but more properly reflect the relative risk involved in making the loans.  Payday loans being high risk, the interest rates are necessarily high as well.
• Borrowers who use these services largely understand the terms and conditions of each loan, and are capable of making informed decisions about how to use the money.
• Payday loan services provide a valuable community service unmatched by any other financial institutions – though increasingly, banks and other lenders are moving into the business. 
• Payday loan consumers tend to use the services as “bridging loans,” in the same manner that local governments and businesses uses bridge financing to carry them through periods with low sales volume. 

Consumer Protection

When payday loans involve deceptive practices, the Federal Trade Commission intercedes, as it did in a lawsuit against lender AMG Services.     

 U.S. District Judge Gloria M. Navarro recently ruled that the defendants deceived consumers about the cost of their loans by imposing undisclosed charges and inflated fees.  In many cases, the defendants’ inflated fees left borrowers with supposed debts of more than triple the amount they had borrowed.  In one typical example, the defendants allegedly told one consumer that a $500 loan would cost him $650 to repay. But the defendants attempted to charge him $1,925 to pay off the $500 loan.  The defendants used deceptive loan documents in connection with at least five million consumer loans.  

Adopting an earlier recommendation from Magistrate Judge Cam Ferenbach, Judge Navarro found that the defendants’ lending practices were deceptive because by failing to disclose charges and inflating fees, they hid from consumers the true cost of the payday loans they offered.  

This decision follows another significant ruling in the FTC’s favor. In March, after the defendants claimed their affiliation with American Indian tribes shielded them from federal law enforcement, Judge Navarro ruled against them finding that the FTC Act grants the agency authority to regulate arms of Indian tribes, their employees, and their contractors. 

In her latest decision, Judge Navarro noted that the key portions of defendants’ loan documents were “convoluted,” “buried,” “hidden,” and “scattered.”  And she further cited evidence indicating that the defendants’ “employees were instructed to conceal how the loan repayment plans worked in order to keep potential borrowers in the dark.” 

The FTC has sued a number of payday lenders for engaging in unfair and deceptive practices targeting financially distressed consumers who are seeking short-term loans. 

Sources:  USA Today at http://www.usatoday.com/story/money/personalfinance/2014/04/20/id-nv-ut-have-among-highest-payday-loan-rates/7943519/; Pew Charitable Trust at http://www.pewstates.org/research/featured-collections/payday-lending-in-america-85899405692; Consumer Financial Protection Bureau at http://www.consumerfinance.gov/askcfpb/1567/what-payday-loan.html; Federal Trade Commission at http://www.ftc.gov/news-events/press-releases/2014/06/us-district-judge-finds-payday-lender-amg-services-deceived