Bailout

Loan sharking datapoints of the day

By Felix Salmon

Are legal payday lenders a superior alternative to the loan sharks of old? Or are they they loan sharks of old? Just look at what happened in New Mexico, which tried to crack down on payday lenders by limiting the amount of money a company could charge in interest on a short-maturity loan. No problem, said the lenders, and just started selling a new product — an even worse product — which got around the law by having a maturity of over 120 days. They even provided their borrowers with Truth-in-Lending Act disclosures! Like this one:

In case you can’t see clearly, this shows a $100 loan which is due to be repaid with 26 bi-weekly installments of $40.16 each, plus a final installment of $55.34. In total, the borrower, Oscar Wellito, has to pay not only his $100 principal back, but also $999.71 in interest, for a total APR of 1,147%.

The New Mexico attorney general is trying to get this kind of thing made illegal, but it’s still going on — and not only in New Mexico, either.

Wellito ended up making four payments on this loan, for a total of $160.64, before he complained to the New Mexico attorney general’s office and they told him to stop making payments. If those payments had constituted payment in full on the $100 loan, they would have amounted to an APR of something over 460%. In fact, however, after paying back $160.64 on his $100 loan, Wellito had managed to reduce the principal amount outstanding by a whopping 2 cents.

Which is more than this loan would be reduced by after four payments:

Here, the APR is a mere 521%, but somehow the first half-dozen payments don’t pay down the principal at all: after paying $1,169.52 — 25% more than the total amount borrowed — the principal is completely unchanged. Eventually, on payment #7, it finally gets reduced by the princely sum of $3.32.

The first loan, here, was issued by a lender called Cash Loans Now; the second comes from Fastbucks. If both borrowers paid back twice what they originally borrowed and then defaulted, they would still owe hundreds of dollars to each lender. It’s possible that if Cash Loans Now tried to take Mr Wellito to court, the judge would just throw out the case, since the loan was so unconscionable. But if Cash Loans Now just sold its defaulted loan to Fastbucks, while Fastbucks sold its defaulted loan to Cash Loans Now, then both would have bought legitimate debts of over a thousand dollars and wouldn’t have been paid a penny on them: indeed, they would both be out of pocket. It would be very hard for a judge to throw out that kind of case.

I hope that the New Mexico attorney general does manage to get these loans deemed illegal. But in any case one look at them is enough to prove that they’re not in any way being priced off of credit risk — the lenders are likely to make a massive profit even in most cases where the borrower defaults. This is loan sharking, pure and simple — and, for the time being, it’s legal. Isn’t it about time that we have a Consumer Financial Protection Agency which could put an end to this kind of thing?

Full post as published by Macroprudential on January 06, 2010 (boomark / email).