Payday loans mushroom in middle class

Cleveland, Tenn. —- With its quaint downtown and tree-lined streets, this little city in the foothills of the Great Smoky Mountains seems an unlikely epicenter for a $50 billion-a-year financial industry.

But this is where W. Allan Jones founded Check Into Cash, the granddaddy of modern payday lenders, which cater to millions of financially strapped working people with short-term loans at annualized interest rates of 459 percent.

“It’s the craziest business,” said Jones, 55, a homegrown tycoon who founded his privately held company in 1993. “Consumers love us, but consumer groups hate us.”

In years past, a worker might have asked his employer for an advance on his paycheck. Now, with a driver’s license, a pay stub and a checking account, he can walk into a typical payday loan store, postdate a check for $300 and stroll out with $255 in cash after a $45 fee.

No muss, no fuss, no credit check.

And for some, no hope of paying it back any time soon.

By various estimates, Americans pay as much as $8 billion a year to borrow at least $50 billion from payday lenders. That’s more than 10 times the level of a decade ago, according to a report by the California Department of Corporations.

In California alone, customers now borrow about $2.5 billion a year from payday lenders, according to the report.

Nationwide, the number of payday outlets has exploded from zero in 1990 to some 25,000 today, running the gamut from mom-and-pop outfits to national chains.

Advocacy groups have long bashed payday loans as “debt traps,” accusing lenders of baiting customers with easy cash and hooking them into an endless cycle of borrowing.

But as the economy has worsened, payday loans have increasingly become crutches for those higher up the economic scale, said Elizabeth Warren, a Harvard law professor who serves as chairwoman of a congressional watchdog panel on the $700 billion bailout for the U.S. financial system.

More middle-class families use the loans “to put off the day of reckoning,” she said. “Too many families live with no cushion, so when something goes wrong, they turn to payday lenders.”

As an alternative to payday lending, some credit unions and other lenders have begun offering short-term, small-dollar loans at annual rates as low as 12 percent. But many borrowers are unaware of such options.

Although industry statistics show that many borrowers repay on time, others do not. Instead, they borrow from a second lender to pay off the first, or repeatedly roll over or “flip” their loans into new ones, sinking deeper in debt.

The Center for Responsible Lending, a nonprofit and nonpartisan advocacy group based in North Carolina, contends that the average payday loan is flipped eight times, pushing the cost of a $325 cash advance to $793.

Many payday borrowers earn $25,000 to $50,000 a year, and many loan stores that don’t offer check-cashing or pawn services are in middle-class neighborhoods, he said.

In California, the maximum loan amount is $300, which yields borrowers $255 after a fee of $15 per $100. That’s 17.6 percent of the amount borrowed, so if a customer takes a year to pay it off, the annual rate works out to 459 percent —- 17.6 percent multiplied by 26 two-week periods

Lenders say it’s unfair to express their fees as percentage rates because their loans are short-term. Some liken cash advances to taxi rides, saying that both are bad choices for the long haul —- and that borrowers know it.

“We are dealing with people who are a whole lot smarter than what the consumer groups say they are,” Jones said.

Modern payday lending’s roots reach to illegal “salary buying” of a century ago, when loan sharks charged workers up to 300 percent for cash advances on their paychecks. That led to government regulation of small loans, which eventually were made by finance companies and other traditional lenders. But as mainstream lenders abandoned the market, fledgling payday lenders stepped in —- and quickly multiplied.

Jones, widely considered an industry pioneer, got his start here in Cleveland, population 38,000, his hometown.

Two decades earlier, he had dropped out of college to work in his father’s credit bureau and collections business. He hit upon the cash-advance idea in 1993 while wooing a job candidate.

“I found him in this old service station and he had a banner up that said, ‘Check Cashing,’ ” Jones said. “When I went in to try to hire him, I had to keep moving out of the way because customers kept coming in and thanking him for being open.”

As Jones tells it, grateful borrowers were happy to trade 20 percent of their next paycheck for a two-week advance rather than miss bill payments or face bank fees for bounced checks.

Still, payday lenders’ profits are only slightly higher than those of banks and other financial institutions, according to a December 2007 study by Vanderbilt University Law School and the University of Oxford.

The study noted that while payday lenders’ interest rates can be astronomical, they also have higher costs because of defaults.

Jones said his company —- which has 1,270 outlets in more than 30 states —- makes $1.12 on the $15 fee it charges on a $100 loan, after labor, overhead and other costs.

In 2007, Congress put a 36 percent rate limit on loans to members of the armed services, effectively ending cash advances to military families.

When Oregon set the same cap in 2007, it all but shut down payday lending there.

“The pendulum has swung a little more toward the side of the consumer action groups,” said Daniel O’Sullivan, an analyst with Utendahl Capital Partners in New York.

But he’s not ready to count out the industry just yet.

“At the end of the day, there is a need for the product,” O’Sullivan said. “So it comes down to finding something that makes sense for everybody —- something the companies can make money at without putting people into a debt spiral.”

—- L.A. Times staff writer Doug Smith contributed to this article.

How payday loans work

Payday loans are available in about three-dozen states, but not Georgia, with varying fees, regulations and maximum amounts that range up to $1,000.

Borrowers must have a checking account, fill out an application, present a driver’s license or other official identification, submit proof of employment such as a pay stub and postdate a personal check to the next payday, typically two weeks.

The lender agrees to hold the check until the due date, when borrowers have three options:

> Do nothing and allow the check to be cashed by the lender;

> return with cash to buy back the check; or

> “flip” the loan by paying it off and immediately replacing it with a new one —- and paying additional fees.