Costly Cash: How a Retiree Wound Up With a 375% Loan
White couldn't say no, even though he didn't have the money. It had all gone to pay medical bills for the surgery and treatment of his wife's pancreatic cancer. He had spent all his retirement savings and even the money from selling his home in Virginia.
"We were able to overcome cancer, but it had a real impact on us economically and took away all that we worked for all our lives," says White. Today, his wife, a retired school teacher, is cancer-free and continues to visit her doctor for regular scans. But White wanted to help his daughter settle down. So, he went to the local First National Bank for a $5,000 loan. He was rejected.
That's when he took his 2003 Chevrolet Avalanche pickup (pictured, with White) to the Cash Store near his home and used it as collateral for a one-month "auto-title loan" of $5,000. However, he got only $4,000 in cash, but ended up owing more than $5,000, because of fees and charges that were tacked on. According to the loan document written by the Cash Store, White would owe the lender $5,268.50 at the end of the month. The costs included a fee of $1,200, a lien fee of $28, and finance charges of $40.50. According to disclosures in the document, the cost of White's credit at an annual percentage rate was 375.12%.
The Cash Store manager in Killeen, Veronica (who wouldn't provide her last name), declined to explain the details of White's loan. The chain of 280 stores in about eight states is operated by a private entity called Cottonwood Financial, based in Irving, Texas. A company spokesman, Jared Smith, also declined to answer questions about the loan.
A Rude Awakening
Despite the terms, White was happy to get the loan, and he wired the money to his daughter. Before the end of the one-month period, White decided to pay back part of the loan and went in with $1,300 in cash. That's when he got a rude awakening. The Cash Store told him he'd have to repay the entire amount. He could make a partial payment, but he would have to take out another one-month loan, which would come with the same fees and finance charges totaling over $1,250. White realized he could pay about $1,300 for months and still owe close to the original loan amount of $4,000.
White felt trapped. "In four months, I could have paid more than what I went to the store for in the first place, and still owe the original loan amount," he says.
White's case isn't unique. In fact, each year about 12 million people take out short-term loans with interest rates of 400% or more, according to research by consumer advocate group the Center for Responsible Lending.
No Ability to Repay
White's loan also bears an uncanny resemblance to subprime mortgage lending that was extremely popular just a few years ago and was one of the primary reasons for the financial system's near-collapse in 2008.
"Mortgage loans were given out based on the value of the homes, rather than on people's ability to repay, and that led to defaults and foreclosures. That's exactly the case with these short-term loans. They are written out on the value of a car or another asset, not on the basis of whether you will have enough money left over after your regular obligations to pay back," says Leslie Parrish, senior researcher at the Center for Responsible Lending. "That's how people get caught in these cycles of debt, where they spend months just paying out interest and fees on their loans."
Parrish was the lead author of a study released last year that found "59 million payday loans are opened, not due to a financial emergency, but primarily because the borrower could not repay a previous payday loan and afford their regular expenses without it." The report reviewed loan prices in each state and found "that the average $350 loan costs the borrower approximately $59.15 in fees. The result of these 59 million unnecessary loans is that borrowers pay about $3.5 billion in fees."
There's One on Every Corner
White's loan -- where borrowers sign over the title of their paid-off car to the lender -- is a fast growing business. EZ Corp. (EZPW), for instance, ramped up the number of stores where people can get auto-title loans to a total of 393 in the latest quarter, from 263 in the third quarter of 2009. "Auto-title installment loans introduced in the last two years represented three-fourths of the growth in this segment's total revenues," says Joe Rotunda, CEO of EZ Corp., in a conference call with investors. The company doubled its outstanding auto-title loans in just the last two quarters ending December to over $5 million.
Money stores, where people can cash checks and take out auto-title and payday loans, have also become increasingly accessible, mushrooming from just 500 stores in 1990 to 22,000 today.
These alternative lenders have become the only source of credit for millions of people who don't have bank accounts or have spotty credit records. A Federal Deposit Insurance Corp. survey released last year found that over a quarter (25.6%) of all households either have no checking or savings account, or have a bank account but still choose to rely regularly on alternative lenders such as payday loan stores and pawnshops.
These "unbanked" and "underbanked" households are disproportionately low-income and minority. Households with earning less than $30,000 account for at least 71% of unbanked households, while 21.7% of black households and 19.3% of Hispanics were unbanked, according to the FDIC survey.
When people like White get spurned by their bank, they don't know where to turn for money up-front. The money stores on Main Street lure people with signs that say: "Get Cash Today! No Credit Check Required!"
But White became snared when he found out he couldn't just pay down the loan bit by bit. Before retiring, he worked as a defense contractor with the government for about two decades. He and his wife collect Social Security and pensions, which are enough for them to lead "a comfortable life." However, they don't have much left over for lump-sum amounts like what his daughter needed. The auto-title-loan experience has left White shaken.
"Never in my wildest imagination did I think that such a loan product could even exist," he says. "You assume the system will have usury laws and protect you from such things."
White finally was directed by friends at his church to the Covenant Savings Federal Credit Union, where he was able to borrow $4,000 at an interest rate of 16%. He used that money and some of his own to pay off the Cash Store loan, with fees and interest.
White says he has written a letter of complaint to the Texas attorney general and to state lawmakers, asking them to take action against 375% interest rates like his. Says White: "Everybody's got to make a profit, but there should be no place for usury in the 21st century."
Editor's Note: This is the second in a series of stories about money stores and payday lending that DailyFinance has published from March 9-12. On Tuesday, the first two stories concerned the payday lending industry's growth during the Great Recession and how a Texas retiree wound up with a 375% loan for $4,000. On Wednesday, we looked at how several cities in Texas are restricting the spread of money stores in their towns. Thursday's story examined Congress's lost zeal for regulating payday lenders. And Friday's final installment reviews some alternatives to payday loans for folks who find themselves strapped for cash.