Costly Advances

This is a sidebar to this week's feature, "Eaten Alive"

In 1999, Amanda Vail, a Houstonian attending college in Alabama, took in a recently divorced friend and her daughter. She bought them a bed and consequently ended up short on rent at the end of the month. A $400 loan from Advance Payday covered the difference. Fourteen days later, Vail paid $100 for an extension, which she thought was going toward the loan's principal. But it was simply a steep interest payment; she still owed $400, plus another $100 in interest, two weeks later. To it pay it off, she took out a new loan with a different company, Cash Now. To pay off that loan, she pawned her computer.

Industry representatives defend payday loan practices as necessary. Bob Rochford, an attorney with the trade group Financial Service Centers of America, says strict limits on payday lending, such as caps on loan fees, would force many lenders out of business. He prefers allowing competition between stores to set rates. "If they are charging too much," he says, "somebody else will move in and challenge them."


Fringe economy

But consumer groups say price wars aren't happening. The companies charge high fees even as they write off just over 4 percent of loans (according to the Colorado Department of Law) -- a loss rate on par with credit cards charging a fraction of the interest. It's no wonder that payday companies remain immensely profitable. In 2005, Advance America, the nation's largest payday loan company, posted a return on equity of 44 percent, or more than double that of Bank of America.

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Despite a consensus in Texas that the payday industry should be regulated, lawmakers have failed to rein it in. The state caps interest rates for payday lending at between roughly 150 and 570 percent, depending on the size and terms of the loan. Yet even these lofty rates aren't high enough for lenders, who have circumvented state controls by partnering with laxly regulated banks in South Dakota. The banks essentially "export" South Dakota's higher interest rates to Texas, with local payday companies serving as intermediaries. In July, federal regulators finally expressed interest in curtailing the practice.

The thundering of regulators, however, did little more than inspire industry lawyers to look for a new legal umbrella. Exploiting an archaic Texas statute, most payday companies are now dubbing themselves "credit service organizations," entities that can connect consumers with low-interest loans but in the process charge them exorbitant brokerage fees -- or at least that's the idea. Consumer groups hope the state attorney general's office will scuttle the arrangement. Even if it does, says Howard Karger, author of Shortchanged, a recent book on predatory lending, the industry will quickly bounce back with another cheeky scheme. He once visited a payday loan business in New Mexico that gave loans for free but required customers to buy one of several ridiculously overpriced tchotchkes, such as a $100 fake Rolex. "They have an army of lawyers," he says. "Believe me, they are not short on ways to figure out loopholes."

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