High Interest: Protecting the Illegitimate Profits of Payday Lenders

The payday loan industry is booming, but the interest they charge is against the law. Now they want the law changed - or they'll be out of business.

By Adrian Duyzer
Published October 06, 2006

The federal government is poised to introduce new legislation aimed at regulating the payday loan industry. According to media reports, the legislation will give authority to the provinces to set short-term interest rate limits for payday loans.

Getting this legislation passed is a top priority for Michael Thompson, president of the Canadian Payday Loan Association (CPLA). He says the association wants to "make sure that the legislation gets introduced quickly and passed through Parliament quickly".

In a telephone interview with Raise the Hammer, Mr. Thompson gave several reasons for this urgency: the need for "regulatory certainty", payday lending's poor image in the media, and putting a halt to "certain issues in the industry that are potentially hazardous to consumers".

However, a recent British Columbian Supreme Court decision against a payday lender has sent shockwaves through the industry and provided a powerful motivation for new laws: without them, payday lenders may not survive.

Money Mart loaned $129,092,000 USD in the first quarter of 2006
Money Mart loaned $129,092,000 USD in the first quarter of 2006

Criminal Lending

Payday lending is a lucrative business: the interest and fees are hefty, and a lot of loans are being taken out. Canada's Money Mart locations loaned $129,092,000 US in the first quarter of 2006 (Money Mart is a subsidiary of Dollar Financial, an American company).

But there's a catch for the consumer. Borrowing money from payday lenders is costly. CashMoney, a popular payday lender in Ontario, charges $22 for every $100 loaned. That works out to an annual percentage rate of interest (APR) of 575 percent. If you borrowed $1000 at this rate, you'd owe $5,750 after just one year!

There's a catch for the industry too, and it's a big one: Canada's Criminal Code prohibits an APR greater than 60 percent.

That's why Canada's payday lenders charge less than this interest rate - at least, for the part they call interest. They also charge fees that they claim don't count as interest.

In CashMoney's case, for example, the $22 is a fee, not interest, according to the woman I spoke to on the phone. According to them, CashMoney doesn't charge interest at all.

If that sounds like mere word juggling to you, maybe you should consider a career as a judge, because that's exactly what the Supreme Court in British Columbia recently decided.

In a class action lawsuit against A OK Payday Loans, Justice Brenda Brown ruled that fees and late charges are interest - and so the rate the company charged for the loans was criminal.

She also called the fees "unconscionable" and "inequitable". It is this kind of criticism - that payday lending is an unfair practice that harms borrowers, especially those who can least afford it - that drives the controversy over payday lending.

Three Main Defenses

The people who take out payday loans are typically those who are economically disadvantaged, a fact acknowledged by defenders of the industry.

Tom Lehman, assistant professor of economics at Indiana Wesleyan University and author of In Defense of Payday Lending, writes that "payday borrowers are more likely to have poor credit histories and to have worked with credit counselors in the past", "are more likely to have had one or more bounced checks in the previous five years", and "are also more likely to have been called by a collection agency for overdue bills".

High interest rates and the encouragement of bad borrowing habits are the main concerns of consumer advocacy and anti-poverty groups.

The business model of the industry is based on cyclical borrowing - paycheque to paycheque - and this practice combined with high interest rates drives financially vulnerable people into a spiral of debt, they believe.

The payday lending industry responds to these criticisms in three main ways. First, since their clientele is high-risk, they need to charge a higher "risk premium". This risk premium is extra money to make up for the loans that are never repaid.

However, according to a study (PDF) by Chris Robinson at the School of Administrative Studies at York University, the "lending portfolio" of payday lenders is "very diversified in the form of many very small loans, and hence the loss rate is reasonably stable". He points out that the risk for traditional banks is much greater: "A single corporate default can cost a bank far more in loan losses than the total loan losses of the entire payday lending industry in Canada for a year."

Payday lending opponents also argue that it is precisely because the clientele is high-risk - i.e. they are poor, financially uneducated, or both - that they need protection.

Second, the costs associated with giving a payday loan, like paying the rent, the bills, and the employees, are the same as they are for a large loan taken out from a bank. Payday lenders argue that they need to charge higher rates simply to cover these costs, which banks recoup over the long terms of their loans.

It's true that payday lenders could not survive if they were forced to comply with an annual interest rate of 60 percent or less, although I find it difficult to feel much sympathy for a business model that is incompatible with the law.

As well, the actual cost associated with each loan is estimated by Robinson, in a highly detailed analysis, to be $6.87 in 2005, making current rates extremely profitable.

The third defense of payday lenders is that they provide a valuable service which ought to be legal. This appears to be the main reason why the CPLA is lobbying for provincial regulation of the industry. Without new legislation, payday lending in its current form is doomed in Canada, because it's against the law.

Uncertain Motivation

The motivations of the CPLA in pushing for provincial regulation, however, may not be quite that simple.

Dr. Lehman is adamantly opposed to regulation of the payday industry. I contacted him and asked him why the CPLA would press for regulation, since he believes regulation is bad for business as well as consumers.

After disclaiming that he "cannot claim familiarity with Canadian banking regulation or laws governing payday lending", he offered this interesting explanation:

[One] possibility is that the CPLA is asking for regulation of the industry as a means of insulating their members from non-CPLA competition in the market. The market for payday lending has grown rapidly in the past decade. Typically, as competition grows in an industry, the "established" firms (perhaps those in the CPLA) begin to feel pressure on their market shares due to new competitors. This almost inevitably leads them to seek help from government through regulations that limit entry into the industry.

Of course, this is not how they would explain it. [CPLA members] argue that they are "protecting payday loan consumers" from upstart rivals in their market who do not "play by the rules" or who do not abide by the CPLA's "Best Practices". Some of this could be desired by CPLA members as a way to "clean up" the industry and improve public perception (which competition would do eventually anyways). But, most often this is code for protecting their own market shares from new entrants into the market.

(CPLA president Michael Thompson denies this, saying, "it is the position of [the CPLA] that new regulations be geared towards allowing the maximum number of entrants to the market".)

Dr. Lehman also believes that regulation will eventually lead to higher prices, because there is "less downward pressure on prices and fees from competition". Regulations "end up harming consumers by making them pay higher fees than they would otherwise pay if competition were more open and less regulated".

In Canada's currently unregulated market, however, prices have increased. Money Mart raised its fees two years ago. The Cash Store also raised its rates. On June 2nd of 2005, a two-week $360 loan from Money Mart cost $52.09 in interest, today, that amount is $60.16.

Regulation to the Rescue?

Will provincial regulation help Canadian consumers? It might, but it's interesting that the industry is seeking provincial rather than federal regulation in the first place.

Dr. Lehman speculates, "they may believe they have a greater probability of influencing regulations and legislation passed at the more local provincial level than would be the case at the national level".

The approach has worked in the United States. Writing for Slate, Brendan Koerner reports that "[s]ince 1990, the industry has convinced legislators in 24 states to exempt their storefronts from the strict APR ceilings that govern banks and credit cards".

Mr. Thompson says that provincial regulation makes sense because smaller financial institutions like credit unions are provincially regulated (unlike federally regulated banks), and because "most of the issues are related to consumer protection".

However, Bruce Cran, President of the Consumers' Association of Canada, says provincial regulation will create a "hodgepodge" of regulations. He believes the current federal legislation, which mandates a maximum APR of 60 percent, is sufficient. "The only thing lacking right now," he said in a telephone interview, "is enforcement of the law."

He is convinced that provincial legislation will fall short of the protection consumers need. Recent workshops held by the government of British Columbia with payday lenders and consumer advocacy groups were "segregated," he said, "so we never actually got a chance to talk to the payday lenders."

Mr. Cran has some interesting advice for consumers who owe large amounts of interest to payday lenders: "don't pay it".

"Recent court decisions have made it clear that the rates charged on these loans are criminal," he said, which means companies can't collect it.

If you would like to speak up on this issue, contact Vic Toews, Minister of Justice, or your local Member of Parliament.

Adrian Duyzer is an entrepreneur, business owner, and Associate Editor of Raise the Hammer. He lives in downtown Hamilton with his family. On Twitter: adriandz


View Comments: Nested | Flat

Read Comments

[ - ]

By daypay (anonymous) | Posted October 10, 2006 at 00:11:43

Great expose. I can't believe no one else is looking at this!

Permalink | Context

[ - ]

By adrian (registered) | Posted October 11, 2006 at 14:43:56

The legislation has been introduced. From the Star on Friday, Oct 6:

The federal government has introduced Criminal Code changes that would end the legal uncertainty over high-interest short-term lending by the booming payday loan industry.

The bill presented today would give the provincial governments authority to regulate payday loans, which typically involve lending a few hundred dollars to a get borrowers through to their next payday.

Justice Minister Vic Toews said today the proposed legislation gives provinces the tools they need to protect consumers from what he called “questionable business practices.”

Permalink | Context

[ - ]

By jazzfan (anonymous) | Posted January 17, 2007 at 23:28:04

I don’t need or want my elected government telling me how to spend $35.  I’m not asking for the government to trust me with $35; I’m telling my government not to meddle in my life over $35 choices.  $35 is the fee for a $200 loan (California and Arizona.  In Oregon it is $20.  In Nevada it is $18 per hundred).  Perhaps government can solve some real problems, like education and social security.  What’s next…I can’t buy ice cream because it has too much fat, or too expensive?  If I need $200 to pay my rent (because if I don’t I’m on the street), I don’t need my government telling me I can’t spend the $35.  If $35 I my best financial option, because I can’t get a loan anywhere else, including from my government or government regulated banks, then don’t you think government should focus on something else?  The industry is regulated by the State and must operate within every consumer protection law.  The non-sense needs to stop and government needs to focus on the important things like education, taxes, and infrastructure.  I sometimes use the payday loan service, I follow the legislative process of new bills, and I’m a voter.  Protect consumer rights to financial alternatives or lose my vote!

Permalink | Context

[ - ]

By PB (anonymous) | Posted May 01, 2007 at 14:26:44

I agree with jazzfan, the government has more pressing issues to deal with than this one. Perhaps if they increased the hourly wage instead of lining their own pockets first, the poor would be in less need of loans. Also if the government looked at banking practices and the Big Banks focused on individuals not just major corporations perhaps they would not loose customers to PDA companies. The banks are not user friendly to most individuals and especially not the the people who use pay day loan establishments. Bank fees are very high and numerous.
There will always be individuals who rip off others, both lenders and borrowers. My experience as a pay day loan employee is that we are very careful regarding who we lend to and how much we lend because we want the loan repaid and do not want to over burden the customer. In many cases they are not very good at money management so we try to watch out for both of us. Except for late fees we do not hear much about what happens when a customer is in default. First if the person receives their income from any government source ie: ODSP, Welfare, Pensions etc. you can not garnish that money so if they do not pay, we take the hit(if the customer is not above board they can legally steal from us)on the other hand if that same person owes money to the government their "overpayment" is deducted from their cheque each month. If we have to take a customer to Small Claims Court it is very time consuming and expensive. We pay up front and the customer has to pay if we get judgement and are able to collect. The fees charged by the court are inflated for what they do and often end up being more than the loan itself.
We take the forms off the net,fill them out, drive to the court house, pay to park and file them. The first document,of at least four,is the Plainfiff's Claim which costs between $75-$145.00. In the end(up to and including garnishment)it can cost the customer about $300.00. That does not even include any court appearances. Three hundred dollars seems very steep when we charge only $14.95 for a transacation and 1% per week. Do the math, that is less than $120.00 for a two week loan of $100.00. And there are people who think that $6 or $7.00 is enough for the transaction fee? Perhaps they ought to try and pay rent, ulitilies wages and unpaid loans out of $7.00 per loan.
We have long term customers who treat us well and who we treat well. Without us they would have to go to the food bank in between pays or be without heat and hydro because the utility companies will not wait. Do not paint every PDA company with the same brush not everyone is out there to rip someone off.
Finally it would be nice if people began to take some responsibility for their own actions and stopped whinning. Credit is credit no matter what kind and some people can not handle it no matter where it comes from. Cutomers have a responsibility to find out the rates when they borrow, they choose to borrow so they should look for the best rates. The problem is that alot of times they borrow from too many places at once Is this really any different than having too many credit cards? Why doesn't the government go after credit card companies and get them to lower their interest rates as well.

Permalink | Context

[ - ]

By samandkris (anonymous) | Posted August 29, 2008 at 01:14:05

well all i have to say is that a person is on ODSP he is either physically or mentally ill. SO how is it legal to lend someone with an unsound mind money? If he may not even know what he is doing because of his disability?

Permalink | Context

[ - ]

By KristinaD (registered) | Posted March 05, 2009 at 00:58:16

A payday loans is one of the most popular short-term financial alternative of most consumer. However, the uncertainty on this industry isn’t new for some people, due to the misconceptions being thrown to this industry. For instance, some online payday loan companies in Nevada have been slapped with a lawsuit. Apparently, they had been engaging in some offside collection practices. They haven't been stripped of their license to give online payday loan, but until a settlement is reached they have to be careful of how they settle their debt resolution. You can't go around telling people that they are going to be arrested if you aren't the police.

Permalink | Context

[ - ]

By Marques_O (registered) | Posted March 11, 2009 at 06:22:21

It's commendable that some would offer solid advice regarding payday loans. My concern, however, is that you aren’t taking into account irresponsible borrowers who are living beyond their means. Payday Loans in British Columbia has been raging a battle against payday lending for some time now. They are passing legislation that will cap rates on borrowers who have defaulted on their loans. Another piece of payday lending legislation just recently failed in Arizona that would have capped interest rates on defaulting borrowers as well. The state is in a pitched battle, as lenders want to pass legislation that will allow them to stay open past 2012, when the practice will no longer be legal. Let us hope that doesn’t happen, in Arizona or in beautiful British Columbia.

Permalink | Context

View Comments: Nested | Flat

Post a Comment

You must be logged in to comment.

Events Calendar

There are no upcoming events right now.
Why not post one?

Recent Articles

Article Archives

Blog Archives

Site Tools