Commentary How Payday Lenders Trap Borrowers in Cycle of Debt The problem lies in predatory behaviour which would be absolutely condemned, at least publicly, by the head offices of these outfits but in fact are reinforced in the form of pay raises, bonuses and promotions. By RTH Staff

Published May 20, 2016

Note: This letter was submitted to Hamilton City Council in February and has been shared with Raise the Hammer. The author wishes to remain anonymous but their identity and experiences have been verified by a third party.



Payday loan shop at Main and Dundurn (RTH file photo)

Dear Mayor and Hamilton City Councillors,

I have been motivated to write to you after having read in the Hamilton Spectator an article regarding your efforts to effect some further restrictions on payday loan providers. Having, sadly, worked briefly for two of these outfits, I am hoping I can shed some light on the operations of these outfits and the real issues which need to be addressed in reining in these operators.

The article reports that you are hoping to force these short term lenders to post their rates and the rates of other loan providers for comparison. I'm sure you know it is already mandatory to post the effective annual interest rate in a prominent spot in all payday loan store fronts.

Furthermore, I sense that you already know that measures such as these have little effect in deterring someone who has entered one of these businesses in hope of leaving with cash.

The sad fact is that many clients simply don't understand the math, they don't understand what they've signed up for and, most importantly, they don't understand their options. They are almost always only concerned with how much cash they will be leaving with that day.

The effective interest rate associated with the 21 percent fee for a payday loan is staggering, over 600 percent in fact. However, in my opinion the interest rate is not the real problem when evaluating loans which have mushroomed to four times their original value.

The problem lies in predatory and I believe illegal behaviour which would be absolutely condemned, at least publicly, by the head offices of these outfits but in fact are reinforced in the form of pay raises, bonuses and promotions.

It is important to remember that the payday loan business model is not profitable if clients only come in once in a while, take a loan, and then repay that loan on time without taking another loan. The business is dependent on repeating the 21 percent fee per loan.

Of course there is mandated literature at all locations emphasizing that these types of short term loans should be used in emergencies only and that one should avoid getting trapped in the payday loan cycle. But that message in completely at odds with the structure of the payday loan business model.

Therefore, a valued employee is one who will get their clients into the cycle of borrowing, repaying on time (because you can't borrow again until you have completely paid off the loan) and re-borrowing. In fact, if a client repays on time he or she would almost certainly have to re-borrow since in most cases the amount required to repay the loan is at least 50 percent of their take home pay cheque.

What most clients don't understand is that the way out of the predatory cycle is to pay the loan off in increments which they can afford without re-borrowing. Even though the late interest charges for balances that go past due are (I believe) 59.9 percent, incremental payments result in much lower fees per loan. However, this is the last thing payday lenders want their clients to know and on the front lines there have been a number of ways devised to stop it from happening.

But before I explain these practises I would like to illustrate for you how the cycle works and why incremental payments (even at 59.9 percent interest) are a better option for the client and what's at stake for the payday loan operators. I will use a $400 loan to illustrate.

The following is a schedule of the payday loan cycle resulting from an initial loan of $400.

Schedule of Loans and Payments Amount Borrowed 400.0 21% Borrowing Fee 84.00 Beginning Balance 484.0 First Payment 484.0 New Balance 0 Amount Re‐borrowed 400.0 21% Borrowing Fee 84.00 Balance after 2nd loan 484.0 2nd Payment 484.0 New Balance 0 Amount Re‐borrowed 400.0 21% Borrowing Fee 84.00 Balance after 3rd loan 484.0 3nd Payment 484.0 New Balance 0

And so on.

As you can see, every two weeks the client is incurring a fee of $84.00. After just five pay periods, the total fee being paid by the client would be $420.00,

Now, let's assume that same client borrows $400 but chooses not to get trapped in the cycle. He decides to pay this loan out in the amounts of $121 per pay period. The schedule of payments would look like this:

Schedule of Payments Amount Borrowed 400.00 Total Fees 21% Borrowing Fee 84.00 84.00 Beginning Balance 484.00 1 st Payment (121.00) Balance 363.00 59.9% interest for 14 days 8.34 8.34 New Balance due after 14 days 371.34 2nd Payment (121.00) Balance 250.34 59.9% interest for 14 days 5.75 5.75 New Balance due after 28 days 256.09 3rd Payment (121.00) Balance 135.09 59.9% interest for 14 days 3.10 3.10 New Balance due after 42 days 138.19 4th Payment 121.00 Balance Due 17.19 59.9% interest for 14 days .40 .40 New Balance after 56 days 17.59 101.59

As you can see, in this case after five weeks the client is out of debt, having incurred fees and interest charges that are less than 25 percent of the fees which would have been incurred had they become trapped in the cycle.

So, why don't clients choose to pay out in increments? There are many answers to that question and I certainly can't address all of them. But I can tell you that for obvious reasons, the practice is highly discouraged by the lender.

The first way in which it is discouraged is simply to confuse the client with misleading and confusing numbers. For example, "Mr. Jones, it would be far better for you to pay in full and just re-borrow the money today. If you re-borrow the percentage is just 21 percent, but if you pay late the percentage is 59.9 percent. So, you can see you would save a lot of money just re-borrowing."

The other ways in which incremental payments are discouraged involve the use of Pre-Authorized Debit forms (PADs) and post‐dated cheques. All clients who take out a payday loan are required to fill out a pre‐authorized payment form or to leave a postdated cheque in the full amount due.

The following two examples illustrate how these items are used to intimidate or trick the client into paying in full.

I know one store manager who outright refused to accept partial payments from her clients. She would tell them to pay in full or not at all. If they didn't pay in full she would tell them that she would set a PAD on their account on the next payday for the full amount plus the 59.9 percent late fee.

Many clients, not understanding the difference between fees and per annum interest rates, thought that this meant they would be paying an additional 59.9 percent above what they already owed. In this way they were bullied into paying in full and therefore took another loan.

This particular manager was the most profitable manager in her division and earned quite a bit in bonuses. I have no idea if her superiors were aware of her tactics.

When I worked briefly for one payday lender I asked our trainer what the policy around people wanting to make partial payments was. I was told that in the case of someone wanting to make a partial payment, to accept the payment, then to tell the client that they couldn't have their postdated cheque or their pre‐authorized debit form back because it had accidentally been sent already to the bank.

Then, we were to use that form on the next payday to get the full amount from the bank account, and then reimburse the client for the overpayment (the partial payment).

If you were to ask payday lender execs if this is their policy regarding people who want to make partial payments, I am sure they would tell you "absolutely not!" But this is just one example of the disconnect which exists between the front line decision makers and the head office.

Head office is interested in profits and, in my experience at least, doesn't perform effective oversight to make sure their branches are in compliance. As a side note, thankfully this situation never arose for me as I quit shortly after I was hired.

There are strict rules around the use of PADs which are set by the province. However, they are not followed and almost all the time the clients have no idea of their rights. If a PAD or postdated cheque is issued on a client's account and is returned NSF it usually means the client will be charged a $40 fee by their bank.

Additionally, the payday lender charges them a fee. Yet, lenders will put these items through again and again, even when they know there is no chance of retrieving any money, just to bully the client into paying. In this way the original loan balloons as interest also starts accruing on these fees as well.

In my opinion, the most effective way to help those who use payday loan services would be not to post interest rates but to make it mandatory to post an incremental payment schedule such as the one I have included in this letter so that the client can better understand the options available to them.

Furthermore, I would make it mandatory to put up signage which clearly states that a payday loan clerk must take a partial payment if offered and that PADS and post dated cheques must be returned to the client upon receipt of a partial payment. The signage should also include the toll free number of the company's compliance department as well as the number of a governmental enforcement body.

In closing, it is not my intention to single out any particular lender, which is why I haven't named the two outfits I worked for. I am sure similar abuses occur at all of them. I hope my letter has been of some assistance in your efforts to further regulate the industry and that it may result in helping clients to understand their rights and how to use these services more knowledgeably.

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