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."
Payday loans aren't available only on payday. The term derives from the fact that they are designed to help borrowers get from one paycheck to the next, usually about two weeks.
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.
"That's common, that's hoped-for, that's expected," said Ginna Green, the center's California communications manager. "These loans are designed to be flipped and refinanced, over and over and over."
Practices defended
Lenders say that Green's organization and others exaggerate borrowers' difficulties.
"Consumer groups are very effective at using that 3 (percent) or 4 percent of horror stories about people who misused the product and got more loans than they can afford," said Steven Schlein, a spokesman for the Community Financial Services Association of America, a trade group.
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.
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