The Big Squeeze

She didn't know the loan would make her ill, make her cry, even make her think her husband would want a divorce. In the beginning, all Kristy knew was that a $300 payday loan would help pay for the vacation she and her husband, Michael, had planned in Eureka Springs, Arkansas.

Getting the extra money was simple. In October 2004, she clicked on a pop-up ad on her computer; the ad exclaimed, in bold, how quick and easy the loan application was, how fast the money would be delivered to her. All Kristy needed was a checking account (something all payday lenders ask of their clients), a pay stub and a copy of her bank statement. No worrying over a credit check, either. Quick Payday, the payday lender she used to finance her Arkansas trip, only required Kristy to grant access to her checking account. Once she did, she got a loan for $300. Two weeks later, Quick Payday would withdraw $360 from her account.

That was the plan, anyway. But at the end of two weeks, she didn't have the entire $360. She paid $60 in interest to extend the loan for 14 more days, meaning two weeks later, she would owe the loan's principal, the $300, plus another interest charge of $60.

It would be months before she realized how much that interest could add up. Viewed as an annual percentage rate, that $60 amounted to 730 percent interest, 595 points higher than what Texas law allowed for a $300, 14-day loan. Yet in this case, the loan was beyond the law of Texas--just as all payday loans are. It's the reason for Kristy's wrath, the reason she's now come forward with her story. (Kristy, a legal secretary at a prominent Dallas firm, asked that her last name be withheld.)

Quick Payday has its offices in Logan, Utah. Utah has no cap on payday loan interest. Quick Payday, then, can apply, with impunity, the lax standards of that state's usury laws to any other state because Quick Payday needs only to abide by the statutes of Utah, even when making loans outside it.

A similar business model is used by storefront payday lenders with offices across the nation. Three of the largest chains are based in the Dallas-Fort Worth area: ACE Cash Express Inc. of Irving; Cash America International Inc. of Fort Worth; and First Cash Financial Services Inc. of Arlington. All of these storefront payday lenders have partnerships with banks outside the state, often in Delaware, where usury laws are a joke. The bank partnership enables a storefront payday lender to charge, in Texas, the interest rate of the bank in Delaware. Why? Because the interest rate in Delaware can be exported across state lines. Even better for the storefront lender in Texas, there's not a damn thing a state regulator can do to stop the violation of Texas' usury laws, because Texas regulators have no jurisdiction over Delaware's interest rates.

Had Kristy known about the exported interest rates--the "loan sharking," as she calls it--she never would have asked for the money. Never would have put herself in a situation where she couldn't pay off her first loan, where she could only extend it for two more weeks and pay off the interest, the $60.

Kristy took out a second loan for $200 with a company called ICS Debit. But the debt trap continued. So Kristy took out a third loan on November 17 of last year--this one from another Internet lender, Preferred Cash, for $300, with $60 in interest on the loan and an expectation that it would be repaid in full in two weeks.

Only that didn't happen, either. And now Christmas was coming, and all she could do was pay interest on all these loans. She kept coming up short. She hadn't told Michael and didn't want to. Too embarrassed. Best, then, to keep up appearances. Buy as many presents as last Christmas. Buy as many groceries as last week. Act as if things were fine.

Things weren't fine, of course. The interest she'd paid on loans would soon equal the loan amounts themselves. Yet Kristy was still nowhere near paying the loans off. "It started snowballing," she says. Nothing worked. No formula. No dollar-scrimping. The only option, in the end, was to take out yet another payday loan.

This one would be for $1,000--and with it, she'd pay off all the principal amounts from all her smaller loans and all the interest that had festered and grown and made her sick with worry. But that loan, when she got it, was only for $800. The company kept $200 up front. And $800 wasn't enough to pay off the other loans.

The cycle continued. Four more loans totaling $2,100 in the next month and a half. In January, the loans and interest--that damn interest--consumed Kristy's checking account. Soon, she owed her bank $800. She turned to her mother, Helga, who helped, but by mid-February Kristy knew she'd need Michael's support. She worried he'd divorce her. She owed maybe $3,000, and they weren't rich; Michael worked as a car mechanic. But he didn't yell when she told him. "It got to the point where she was crying, she was ashamed," Michael says. "There was nothing that I could have said or done to make her feel any worse. It was done."

On February 28, they paid off the loans, the interest, everything.

The final dollar amount? Perhaps it's best to think of it like this. In October, Kristy took out a $300 loan. In March, she'd paid off all her lenders but spent nearly $8,000 in the process.

Consumer advocates find stories like Kristy's all the time. The Dallas Observer spoke with two others. One of them is an elderly woman whose payday lender sought prosecution from the Dallas County District Attorney's Office. The other is a Fort Worth schoolteacher who took out payday loans for a year, three of them from ACE Cash Express of Irving. He calls payday lending "a debt trap" and had ACE's collection agencies threaten him with jail time for not repaying his debt, a practice that's illegal. Critics of the payday industry say lenders and the collection agencies they hire don't care about legalities. They care only about profits. As a result, there are hundreds of stories like the ones you'll read here. (Most of the others remain in the shadows. It's one thing to admit you had a problem with a payday lender, quite another to admit it to the media. It's for this reason that some of the people in this story are identified only by first names.)

Critics say the payday lending industry is legalized loan sharking, preying on the downtrodden, its revenues predicated on a simple conceit: Payday borrowers will always have a tough time repaying the interest and the loan by the next paycheck. Indeed, the Center for Responsible Lending, a national community development organization, says the average payday client pays $800 to borrow $325.

The industry has a different story to tell. Banks typically don't issue small loans; it's too costly a practice. So payday lenders have taken their spots. Today, the industry's providing a service few other financial outlets do. With no credit checks, payday lenders extend money to people who otherwise wouldn't qualify. The interest rates are high because the borrowers usually have bad credit, so the loan is risky. As for the cycle of debt, the Community Financial Services Association of America, a trade group representing roughly two-thirds of the payday industry, says 60 percent of its customers either didn't renew their loans last year or renewed them between one and four times.

But renewing a loan four times is still a lot of money. Just ask Kristy. A $300 loan with interest of $60, extended four times, means a customer will pay $240 in interest on a $300 loan. "This particular industry has been known for a very long time as trying to disguise usury through sham transactions," says Jean Ann Fox, director of consumer protection for the Consumer Federation of America.

The industry says its need in society is reflected by its growth. There are 22,000 payday loan offices nationwide, up from 10,000 in 2001, according to industry literature. Payday lenders offer $40 billion in loans each year and collect $6 billion in finance charges from borrowers, according to a 2004 report by Stephens Incorporated, an industry analyst. In Texas, 55 payday companies operate 1,668 locations, says Leslie Pettijohn, Texas' consumer credit commissioner, who regulates the payday lending industry in the state.

Federal and state authorities are trying to keep up. In March, the Federal Deposit Insurance Corporation, the regulator of U.S. banks, said a bank that partners with a payday lender could not grant a client more than six loans a year. The FDIC believed some clients were simply taking out new loans to pay off others.

From there, the bad news continued for payday lenders. On June 10, the 11th Circuit Court of Appeals upheld a Georgia statute that said payday lenders must abide by the state's small loan law. The ruling could have Texas implications; next session, the Legislature could cite the 11th Circuit decision as evidence that payday lenders in Texas can no longer partner with out-of-state banks, can no longer import those banks' enormous interest rates.

But that argument--and any legislation that might come from it--could be a moot point. As of July, five of the payday industry's biggest players--Advance America, the nation's largest payday lender; EZCORP of Austin; and the three lenders from this area: ACE Cash Express Inc; Cash America International Inc; and First Cash Financial Services Inc. --all switched their business models. Four of the five lenders have already registered as credit services organizations. ACE Cash Express is considering the move.

A credit services organization (CSO) helps a person pay down her debt, but it can also make loans. If it makes loans, a CSO is considered a broker. A broker, in this case, is a person who initiates a loan but then finds another lender to carry it out and is paid handsomely for the work. In Texas, a broker can charge what it wants in fees for its service. In Texas, there is no cap on broker fees.

The industry says a switch to CSOs will allow customers continued access to the money they need. Jean Ann Fox and other critics say Internet payday lending is out of control, and the switch to a CSO model among the storefront lenders is another example of the industry exploiting clients and skirting the law.

Teresita Perico is an old woman now, and embarrassed besides. She'd rather not discuss the letter Dallas County District Attorney Bill Hill mailed her recently, the one saying she faced jail time for evading her debtors. It's caused too much grief, this letter, "and it's taken a toll on her health," says Tess Young, Perico's daughter.

So Tess Young will tell the story. And she'll say this up front: "Nobody should get away with charging that much interest."

Perico's husband, Jose, has Alzheimer's and lives in a retirement home in Irving. Young needs help, too. She's recovering from a divorce. Last July, needing money, Perico turned to Americash, a payday lender. She repaid her first loan and took out another in September, this one for $500 but charging $152 in interest. "To charge that much is exorbitant," Young says. "You're already poor or strapped for cash to begin with."

Then trouble hit. Perico's bank statement carried transactions that weren't hers. Young doesn't think Americash manipulated her mother's account and neither does Perico. But Perico closed it to be safe. The same day she closed the account, she opened another. That's when Americash cried foul. It couldn't extract from Perico's account the money she owed the company. The checking account she'd used to take out the loan no longer existed.

Soon after, the letter from the district attorney came. Perico faced prosecution for writing a bad check and evading the law. She faced the possibility of jail time.

"This is repugnant, especially in a state that prides itself on Christian values," says Harvey Joseph, the Dallas lawyer who took Perico's case pro bono. "Payday loans prey on the poor and the desperate and the ignorant."

But Perico soon found relief. Joseph explained Perico's situation to the DA's check-writing department, and records show that on May 23, Perico's case was dismissed. "They seemed very sympathetic, very helpful," Joseph says of the DA's office. Americash didn't respond to an e-mail seeking comment, and the DA's office didn't answer calls asking how often a payday lender forwards accounts to the district attorney. But a clerk working in Oak Cliff at Justice of the Peace Precinct 5-1, where Perico's file is held, says she sees cases similar to Perico's but with worse outcomes "all the time."

"I just keep coming back to this idea of Christianity," Joseph says. "The New Testament was against interest. So how can a legislature--how can a governor, who signed a bill in a Fort Worth church [in June], allow these people to get away with charging 780 percent APR?"

Well, there are two ways to answer that. The first is that state Representative Dan Flynn, of East Texas, didn't want payday lenders exploiting Texans anymore. The second is that he might have allowed it to happen anyway.

Flynn proposed a bill this past session that would have limited the amount payday lenders could charge to $15 for every $100 borrowed. Most payday lenders charge between $15 and $20 for every $100 borrowed. Teresita Perico's loan was $33 for every $100. "I just didn't feel like there was any consumer protection," Flynn says. "I was trying to stop the cycle of debt."

Celia Hagert is a senior policy analyst at the Center for Public Policy Priorities, an Austin think tank hoping to better the lives of poor and moderate-income Texans. "The main problem with the bill is that it would have allowed [payday lenders] to basically triple the interest rates," Hagert says.

Hagert is referencing a complicated Texas formula that involves a flat fee, interest per annum, dividing these numbers over here, multiplying those over there and then dividing some more. The best way to grasp what she means is to imagine a $300 payday loan. Under current Texas law, the annual percentage rate for a two-week loan is 135 percent. Under Flynn's bill, the APR for a two-week loan could be as high as 390 percent.

"This legislation came from the industry, disguised as a regulatory bill," Hagert says.

It's true that Flynn negotiated with payday lenders on this. If he hadn't, he says, the lenders would have never agreed to a government-instituted cap of $15 in interest for every $100 borrowed. The lenders would have continued charging, say, $33 in interest for every $100 borrowed, he says. But it's also true the opportunity existed for Flynn to be wooed by the payday industry. It sent 16 lobbyists to Austin for the session, at a cost of perhaps $1.1 million, according to filings with the Texas Ethics Commission.

But Flynn maintains he's no dupe. He's a former bank regulator who says Hagert and critics like her always exclude two salient points from their arguments. The first is that payday lenders don't abide by Texas law anyway. Some charge as much as 780 percent APR. His bill would have limited APR to 390 percent. But his bill, he says, should never be viewed in terms of APR; it would have limited the number of loan extensions to two. And this is the second point. So instead of paying off interest week after week, month after month, but never the principal, Flynn's bill said a payday lending client could pay down the interest twice, and then the payday lender couldn't extend the interest a third time. This, he says, makes Hagert's APR argument irrelevant, because the interest would never extend through a year. It would only extend through one month.

Hagert says the bill doesn't prevent the industry from threatening a client to pay off outstanding debt. And it doesn't prevent the client from taking out a new loan with the lender in the face of those threats.

In any case, Flynn's bill died on a point of order in May, never making it out of the House.

"What you should do," says state Representative Burt Solomons of Carrollton, chair of the House Committee on Financial Institutions, "is go ask Congress why they aren't regulating [payday lenders]." Without Flynn's bill, he says, "you can only do so much on a state level."

The offices of U.S. Senators John Cornyn and Kay Bailey Hutchison did not return calls seeking comment on payday-lending legislation. Neither did the office of Congressman Pete Sessions, who represents Dallas. U.S. Senator Elizabeth Dole proposed an amendment July 25 that would severely limit the practice of payday lending to members of the military.

But that's as far as the regulation--proposed or otherwise--goes.

And none of it addresses Internet payday lending. Internet lenders are even more cavalier than their storefront counterparts. A November 2004 report by the Consumer Federation of America found some Internet lenders offering payday loans in all 50 states, though payday lending's illegal in 15. The CFA report says, "Lenders are hard to locate, identify or contact. Some are licensed in their home states, while others hide behind anonymous domain registrations or are located outside the United States." This makes government oversight next to impossible. Worse, some sites fail to disclose the information about fees and interest rates, though the federal Truth in Lending Act requires it, the report says.

Even a storefront payday lender doesn't approve. "This Internet thing, it's a huge problem," says Eric Norrington, vice president of communications for ACE Cash Express.

"But it's real easy to get into," says Michael, a schoolteacher from Fort Worth.

For Michael, it was at first a decision born of parental love. He took out a $200 Internet payday loan that helped him through Christmas 2002. He's a single parent, with a teenage son and daughter wanting things his teacher's salary couldn't pay for. When the solicitations came through his mailbox, the ones saying how easy an Internet loan would be, how quickly he'd have the money, Michael logged on and signed up.

He had never heard of a payday loan until he took one out. "At first, I didn't want to do it, because I didn't want to take out that much interest," he says. The loan carried $20 in interest for every $100 borrowed. "But I thought, things will be better after Christmas, and we'll just kind of take it as it comes. That was probably the big mistake."

The school district paid Michael once a month, but his payday loan came due after two weeks. So Michael paid down the interest and extended the loan until January, his next payday. In January, Michael paid the loan off, but it took "a big chunk" out of his paycheck. He didn't have enough money for his February expenses. He searched for a bank that would give him a small loan with a better interest rate but couldn't find one. Banks didn't do small loans, he discovered. Payday lenders did. Nearly every day, he'd open his mailbox and find another solicitation. After some hesitation, he took out another payday loan.

It went like that for a year. Michael would pay off one loan, find himself short for the next month's expenses, take out another loan, renew it, pay it off and find himself short on the next month's rent or car payment or something else. He'd try different Internet companies, but each left him scrambling. Then in December 2003 he found ACE Cash Express and its $15 of interest for every $100 loaned. Still an exorbitant rate, he thought, but it was also the best he'd seen of any payday lender. Maybe he'd have better luck with a storefront payday outfit.

He didn't. He took out three loans with ACE. The last was for $400.

All the while he researched the industry, finding consumer Web sites that explained "the cycle of debt." Yup, that's me, Michael thought. He came to the conclusion that "I hate payday companies" and vowed not to take out a fourth loan with ACE or with anyone else.

But it would take months before he could pay off ACE. The lender agreed to an incremental, monthly repayment schedule. Michael owed $200 in May 2003 when he got a call from an ACE representative. "She was real nasty," he said. She wanted him to pay the remaining balance. Michael couldn't. Well then, the representative said, expect a call from a collection agency in a week.

One week later, "Aaron Manning" of the "Bad Check Division" left a message on Michael's answering machine. "If I'm unsuccessful in contacting you," Manning said, "you put us in a position to look for alternative ways of contacting you."

Alarmed, Michael called him back. Manning said he was with the state of Texas' "Division of Hot Checks and Fraud." Manning said Michael could lose his teaching license if he didn't pay up. (Michael recorded the phone call.) Manning said Michael could face up to five years in prison. Manning said Michael "had two hours to come up with the entire balance or charges would be filed."

Michael knew something was amiss. He'd lose his teacher's license? A "Division of Hot Checks and Fraud"? He searched the Internet and found Dean Malone, a Dallas lawyer who sues debt collection agencies. Malone took the case.

For one, it's illegal to threaten someone with jail time for not repaying a debt. "But we see that all the time from these collection agencies--especially the payday loan ones," Malone says. Second, it's illegal to pose as a law enforcement agent of the state of Texas. That's what Manning did. He worked for Ditore, Ruibal & Associates, a Florida debt collection agency. There is no Texas "Division of Hot Checks and Fraud."

Malone sued. He wanted to go after ACE, but an arbitration clause in the contract Michael signed with the lender forbade it. Still, Michael recorded every conversation he had with the collection agency and won an undisclosed settlement from it in August 2004--three months after Florida Attorney General Charlie Crist sued Ditore for deceptive business practices. Crist said at the time, "These people were using cruel and forceful tactics to take advantage of citizens who were already down on their luck."

ACE's Eric Norrington says, "Those guys are long gone...We do collections primarily in-house now."

Despite Michael's settlement, he says payday loans are "the biggest scam there is out there."

But that's unfair. At least, that's what Eric Norrington thinks. Once ACE heard customers complain about Ditore, ACE dropped the collection agency, he says. As for the loans Michael took out over a year and a half, what happened to him happens only to "a tiny percentage of the people who use the product," Norrington says. "In dealing with the media, so often we just get mauled."

Robert L. Clarke made the same point two years ago. Clarke's the former comptroller of the currency of the United States, which, among other things, oversees the FDIC, which regulates national banks. In response to a Dallas Morning News editorial with the headline "Payday Loans--Texas needs to stop predatory practices," Clarke, whose law firm has represented payday lenders, said what's lost on the media is a bank's overdraft fee. A $200 bounced check could mean a $50 fee for insufficient funds. But if that customer instead took out a payday loan to cover the $200 expense, the fee on the loan would be $30, at most. "Why some policymakers--and editorial writers--think short-term loans by banks in the name of overdraft protection are just fine and payday loans are not is a mystery," Clarke wrote. He tells the Observer, "People completely misunderstand what's going on. Payday lending is providing a convenience no other financial outlet offers."

Exactly, says Tom Bessant, chief financial officer for Cash America International, a Fort Worth-based payday lender with 863 U.S. locations. "Credit card companies can charge a $30 or $40 late charge," he says. "There are fees for not having an energy bill paid on time.

"If you look at our service relative to getting your electricity shut off...if you don't have the money, then you can't make the payment," he says. "Why aren't more institutions offering this loan? The consumer groups choose to ignore that fact."

For what it's worth, in the two days the Observer spent outside area payday lending storefronts, not one person we spoke with had problems paying off a loan in two weeks.

Melvin Battle didn't either. He's the administrator for federal funds at the Texas Youth Commission. After his recent divorce, "I probably took out six [payday] loans," he says. The interest rates were $34 for every $100 borrowed, "but I was able to pay them all back in two weeks."

But he did feel manipulated for taking out the loans. "I felt more sorry for the other people who were in there," he says. "I overheard a couple say their whole check would be going back to these people."

For the poor and desperate, payday lending is "legalized loan sharking," Battle says. "Once you get caught up in the cycle, it's hard to break."

Exactly, says Jim McMillan, a Houston lawyer who represents plaintiffs in class action and individual lawsuits against payday lenders. He served as local counsel for a nationwide suit against ACE in 2003. A federal court found that ACE violated states' usury laws. ACE agreed to forgive $50 million in bad debt. "And it's maybe one of the cleanest [lenders] out there," McMillan says of ACE. "I don't have nice things to say about these companies. I've just seen too many people hurt."

What happened to Michael and Kristy happens all the time to his clients. "It's a total nightmare," McMillan says. "I had one young lady. Hispanic. She was a maid. And she got into three of these outfits, and everything she made was going to payday loans.

"None of them should be in this business," he says. "In a good business practice, you try to apply the law rather than find ways around it."

McMillan's talking about a credit services organization. It's the new business model for payday lenders, allowing a lender to become a broker. As a broker, the payday lender doesn't have to abide by the FDIC guidelines issued in March, the ones that say a bank partnering with a payday lender cannot give more than six loans to one client in a year. The FDIC guidelines took effect July 1.

But on June 30, Advance America, the largest payday lender in the United States, said it had abandoned its relationship with banks and would act at its 208 centers in Texas as a credit services organization. First Cash Financial Services of Arlington, a payday lender with more than 300 stores in 11 states and Mexico, said the same. A day later, July 1, Cash America's Tom Bessant followed suit, saying the company would now offer loans as a CSO. On July 15, EZCORP of Austin did the same. Its 177 payday lending storefronts in Texas now register as CSOs.

The move meant increased stock prices for the lenders and rosier financial outlooks, which had been dismal following the FDIC ruling.

"Every big payday lender in Texas has switched from the model [with the banks] to the CSO model," says Rich Tomlinson, a Houston lawyer. (That's not quite true. ACE Cash Express now offers a 20-week installment plan that will pay down the loan's interest and the principal at the same time.) "Payday lenders will turn into any shape or form to continue to do what they're going to do," Tomlinson says.

He has extensive knowledge of CSOs. He argued in a class-action suit last summer that the $1,500 a Texas CSO received as a broker fee on a $2,000 loan was "disguised interest" and amounted to "usury." He argued that the broker, not the lender, worked to arrange the loan and was responsible if the loan defaulted. "The real lender here is the broker," Tomlinson says. Yet the broker is not regulated.

Leslie Pettijohn, Texas' consumer credit commissioner, says regulators will get it right eventually. "We will certainly be looking at the activities of the CSOs. We are going to have very strict compliance," she says. "If we see something illegal on the CSO side, it will go to the attorney general's office" for prosecution.

Cash America's Tom Bessant says the switch to CSOs is nothing nefarious. "We're out to make sure that when people need money, they can get money," he says.

It's an argument that angers Tomlinson. He takes the blame for the change in business models. The Fifth Circuit Court of Appeals ruled 2-1 against Tomlinson last summer, saying he failed to state a claim upon which relief could be granted. Had he won the case--well, who knows in what state payday lenders would find themselves today?

"My loss," Tomlinson says, "is the template by which these companies stay alive. And that makes me ill."

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