The tangled web of payday loans

Critics concede payday lenders are filling a need, but label the industry as predatory and driven by greed. It has to be heavily regulated to protect vulnerable borrowers, they say. In the United States, where payday lending has its origins, the industry has become synonymous with legitimized loan sharking.

The Toronto Star
June 19, 2004

The tangled web of payday loans
Quick cash outlets have a downside. Interest and fees can be a trap.
Nicole MacIntyre and Jim Rankin

Kim Elliott's Friday payday loan ritual began as soon as her 12-year-old son was off to school.

First stop was the bank to withdraw $700 from the freshly deposited $900 paycheque from her job as a front desk manager at a Windsor hotel.

A short drive away, $650 went to pay off a loan at Stop ‘N’ Cash, a payday lending store that offers high-interest, short-term loans. As soon as the teller had the cash in her hands, Elliot took out another loan, this time to pay off the interest on a loan at Cash Money, another payday loan store. The transaction was the same there — pay down, loan again, drive to the next lender.

Three hours and three to four loans later, the paycheque was gone. Elliot would then take out about $350 in her final loan of the day, this one to have money to get through the next two weeks.

"I did that every Friday for three years. That was my Friday," says Elliott. "Borrow from Peter to pay Paul, that's basically what it came down to."

Elliott, and her partner, Joe Doucet, were caught in a cycle of debt that had spun way beyond their control.

What had started as an easy, $250 loan from a storefront payday lender led to dozens more. Loans worth several thousand dollars escalated, in less than three years, to payouts of nearly $20,000 in fees and interest — the kind of debt trap usually associated with back alleys and racketeering.

Elliott and Doucet did their business on the main streets, in a wholly unregulated industry that has mushroomed from zero to 1,200 stores in Canada in less than a decade.

"It looks like it's a quick fix for the moment," Elliott says. "All of the sudden you have to pay these people back, and it's just a horrible cycle you get caught into."

The payday lenders say their service is appropriately priced. They argue they're providing a service Canadians want and are flocking to by the thousands.

"Our industry is a requirement for society," says Marni Larkin, marketing manager for Payroll Loans, which has 12 branches across Canada. "The majority of banks will not give these people any type of credit. Where are these people going to go? There's this whole niche market that, unfortunately, are in a very bad position and can't get support from the bank.

"If you add up all of the costs of doing business, our rates are extremely low."

While critics are quick to complain about the industry's questionable practices and high rates, lenders point to the lack of customer complaints. Of the 60,000 complaints received by Ontario's Ministry of Consumer and Business Services, just six were about payday loans.

At the Credit Counselling Service of Toronto, the numbers are different. Each year, program director Laurie Campbell's staff help 45,000 clients with their financial messes. Five years ago, payday loans weren't part of those messes. They now pop up in 5 per cent of cases, and that number, she expects, is going to increase.

"It's a big problem, from what we're seeing, and unfortunately the people that we're seeing using payday loans can ill afford to use them," says Campbell.

Critics concede payday lenders are filling a need, but label the industry as predatory and driven by greed. It has to be heavily regulated to protect vulnerable borrowers, they say.

In the United States, where payday lending has its origins, the industry has become synonymous with legitimized loan sharking. Fifteen states have implemented or enforced existing laws that effectively outlawed payday lending. Thirty-three states, plus the District of Columbia, have chosen to regulate the industry.

In Canada, the business is wide open. While society and the law view the neighbourhood loan shark's service as criminal, there's been no such judgment on payday lending, which offers similar rates — without threats or broken kneecaps.

Ottawa and the provinces have yet to come up with a unified, effective plan to deal with the growing moral issue of protecting consumers from lenders who charge as much as they can. A few provinces license payday lenders, but don't regulate their services. Certain payday loan practices are prohibited in Saskatchewan, but critics say the governance has been ineffective. In Quebec, where all lenders must be licensed, the government has turned down those seeking to open payday loan operations.

A three-month Toronto Star investigation shows lenders target poorer areas — a map plotting 123 locations shows a proliferation in Toronto's low-income horseshoe — charge a confusing hodgepodge of interest and fees, and allow back-to-back loans, which in short order can balloon into huge costs and leave the principal untouched.

Nearly a million Canadians have used a payday loan at least once, according to one survey. The business grows so rapidly and unchecked that not even the industry, which has just formed an association to lobby governments, knows its worth. Estimated revenue ranges from $100 million to $1 billion a year.

As banks move to shut down more neighbourhood branches across Canada, new payday lending stores are opening every week, offering services to the "un-banked."

The banks say they can't afford to offer the short-term, payday loans.

Just how many get caught up in the payday trap in Canada is not known.

One U.S. study released last year estimated that 91 per cent of payday loans are made to "repeat" borrowers, people who take out five or more payday loans per year. A report from Virginia, where regulators monitor payday lenders, found that nearly one in five borrowers took out 13 or more loans a year.

As part of its investigation, the Star took out loans from 12 lenders in Toronto and found the fees and interest charged on a two-week loan — when combined and calculated as an annual percentage rate — ranged from 390 to 891 per cent.

Back-alley loan sharks in Canada may be charged under a section in the Criminal Code that sets the criminal interest rate at 60 per cent per annum. Anything that exceeds that amount is illegal. In theory, the law could be used to charge commercial lenders. But many say the law was ill-conceived and not intended to apply to commercial loans.

It's never been used to go after a payday lender, a fact the industry cites as an indication that society doesn't see the rates charged as usurious.

In the absence of regulation, consumer advocates say, the industry is growing fat off those who have more than an occasional emergency: People living paycheque to paycheque, the financially illiterate, and those who have no other means of securing credit. People with no savings and no investments, clients the banks have little interest in helping.

"They're down to nothing," says John Lawford of the Public Interest Advocacy Centre in Ottawa, who believes the payday loan industry is taking advantage of desperate consumers. Their loan rates are so expensive, he says, it is inevitable that borrowers will eventually wobble and fall.

"It's okay when you're juggling all the balls, but when you start to drop them you don't look so good any more. They would prefer it if you could miraculously keep them going forever, but you can't."

Jean Ann Fox, director of consumer protection for the Consumer Federation of America, says payday loans as they exist in Canada are too expensive, and "a virtual guarantee you won't be able to pay it all back at one time."

Fox was in Montreal this week to tell Canadian regulators of the perils of payday lending. Her message: "You're allowing needy borrowers to be gouged by greedy lenders."

Elliott and Doucet's downward spiral into debt began after Doucet was laid off from his baker's job. By the time he found other work, the payday cycle was in full spin. It reached the point where they were paying $1,400 a month in just interest and fees.

"Just our interest to them was more than our rent, our bills and our food put together," says Doucet, now a factory worker. "We were working for them, basically."

One $520 loan from Stop ‘N’ Cash in particular took Elliott 18 months to pay off. Using Stop ‘N’ Cash rates and information provided by Elliott, the Star calculated the loan cost the couple $5,070.

The spin works like this: On the one $520 loan, every payday, for 39 straight pay cycles, says Elliot, she'd begin by paying off the previous pay cycle's loan principal of $520, plus $130 in fees and interest. That would leave her with $250 from her $900 paycheque. She'd then immediately take out another loan for $520 to cover living expenses for the two weeks to come. She'd do it again the next payday, and the next, and the next.

"I feel stupid for doing it," says Elliott. "We never had the extra $500 to just walk in say, ‘Okay, pay it off, I’m all done with you now.'"

In addition to Elliott and Doucet, the Star interviewed five other borrowers.

Peggy Davis was a city manager with a secret gambling addiction. Ken Mortillaro is a sewer cleaner who fell on hard times after losing his driver's licence. Norm Innocenti is a high school law teacher who admits he should have known better. Ron Oriet was an engineer fresh out of school with student loans. And Margaret Smith, a pensioner, tried to help her son out of financial difficulty.

Each is involved in proposed class-action lawsuits against payday lenders, which allege that criminal interest rates were charged.

In Smith's case, her son, Kenneth, lost his job when the lumber yard where he'd worked for 20 years closed its doors. He found himself out of money and about to lose his apartment.

Smith had a monthly pension of $1,100 and no savings to speak of. But, given the situation at hand, the Windsor woman did what most any mother would do for a son in trouble. She set out to help him.

A neighbour at her subsidized seniors' home had a solution, and it sounded easy.

Smith, 66, lined up at a local Money Mart — the king of the payday loan industry in Canada — waited her turn, and took out a $330 loan against her pension.

In return, Smith agreed to pay back the money, plus an additional $25 in fees and $11 in interest, by postdated cheque, which would be cashed automatically on the day her next pension payment came in. The fees would be waived if she managed to come up with cash prior to payday, something she was never able to do.

The $36 in fees and interest on Smith's month-long loan — when calculated as simple annual interest — amounted to 148 per cent.

Smith paid off that loan, and took out another. And another. She took out a fourth, fully intending to pay it back. But she couldn't come up with the entire amount. "It's hard," says Smith, "to get caught up the next time."

Until her final loan, Smith had been paying down the principal, plus fees and interest each time. Many stores would have given Smith another option. It's called rolling over, extending the original loan by paying down only the fees and interest.

National Money Mart, with nearly 300 stores, prides itself as an industry leader in best business practices, and does not allow rollovers. It even allows customers to escape fees and pay just the 59 per cent interest on their loans, if repaid on the due date. But at Money Mart, the due date is always the day before payday.

"Of course, anybody who had the money in their pocket before payday would not have borrowed money under these terms anyway," says Fox, of the Consumer Federation of America. "That really sounds like another one of the debt traps."

The Star sought interviews with key figures at a number of big payday lenders, including Money Mart, Unicash, Stop ‘N’ Cash, Cash Money and The Cash Store. Citing the lawsuits, none was willing to sit down for an interview.

Money Mart, in a statement, said it is "disappointed" by the class-action proposal, and intends to "vigorously defend" its interests.

Tim Voisin, a Kitchener man behind Stop ‘N’ Cash — a chain of 60-plus stores — didn't respond to Star requests for interviews. The company's lawyer, Steven Sofer, says his client, like other lenders facing lawsuits, believes it has a model that is legitimate.

"Each one of them has a business model which it believes does not violate the Criminal Code, and court will eventually decide whether they're right or wrong," says Sofer.

He points out that not one payday lender has been charged criminally. "I think what it suggests is that everybody recognizes that none of these companies are loan sharks."

Bob Whitelaw is doing the talking for the industry. He is the CEO and president of newly formed Canadian Association of Community Financial Services. Whitelaw was lured away from his previous job as CEO of the Canadian Council of Better Business Bureaus to head up the newly formed payday association.

His old job involved outing scams. With a background in ethics, his new job is chief spokesperson and lobbyist for the payday lending industry, which he admits is maturing, fragmented and suffering from an "image" problem.

Whitelaw defends the business as a service people need, and are using.

"We're accessible, we're friendly. You can walk in, the staff treat you well, and protect your privacy. But we're there to do one thing — help you get that money, and fast.

"It is short term, and it has a distinct end. It forces them to pay it back. It is not a line of credit. And they don't use it daily, by and large," Whitelaw says. "It's almost like the fire extinguisher on the wall. It's there, and if you have an emergency, you call upon it."

Even most critics of payday lending practices agree the industry is filling a gap in short-term financial services — services big banks, now more in the business of wealth management than retail service, have had little interest in offering.

"The banks should be doing all of this business. There shouldn't be a need for it," says Duff Conacher of Democracy Watch, an Ottawa-based government watchdog group.

The big banks do offer short-term credit products, says Maura Drew-Lytle, a spokesperson with the Canadian Bankers Association. Like credit cards, overdraft protection, lines of credit — just not a short-term, payday-to-payday loan.

"Banks are relatively low-risk lenders and, you know, we've got to look at it and say, ‘Do we think this person can pay back this loan or not?’ and make a decision based on that."

Just how risky a business payday lending is, is the subject of debate.

According to a recent government report in Virginia, where the industry is regulated and lenders must provide data on loans, the industry enjoys a default rate of 2.5 per cent.

The "Uncle Angus" Money Mart television ad opens with a shot of a young man sitting in front of a balding, far-sighted, kilted old stereotypical Scot.

"So you want your good old Uncle Angus to lend you $200 until your next payday. Well, let me tell you, in our day we'd break our backs, swept chimneys, gutted fish … pinched every penny, because a world judges a man by the size of his sporran."

The message is clear: It's easier to borrow from a payday lender than family — easy, period.

The ad is the pitchman of the payday lending industry — polished, funny, irreverent, and inviting. Step inside one of these businesses, however, and a potentially gut-churning financial tight-rope act could await anyone going for that nephew's $200 loan.

Money Mart has gone to considerable lengths to operate in a transparent manner. Their loan forms clearly state how much is being charged and what the fees are for.

But the Star found that smaller operations are not as upfront. The fees and wording of contracts are confusing. Interest is stated as one part of the charge, and assorted administrative and other fees are added on.

The names of the fees are different at each stop: a broker fee, insurance fee, a "first party" cheque-cashing fee, "per item" fee, initial "set-up" fee.

Each of the dozen Toronto businesses sampled by the Star either allowed back-to-back loans or permitted clients to "roll over" their loans.

310-Loan, an Internet payday lender, allowed consecutive rollovers on a $100 loan. The result: a two-month, $100 loan that cost $96 in interest and fees. Company president Nathan Slee said rollovers are offered because of customer demand.

At Payroll Loans, rollovers aren't allowed because the practice has the potential to harm customers, says Larkin, the company's marketing manager.

"It sort of drags on. It causes them to get in a position they probably can't afford. We are absolutely against that."

But Payroll Loans, like every other payday lender, allows back-to-back loans, a practice critics point out is no different.

At the 12 lenders, the ground rules for loan defaults were laid out either verbally or on paper.

Employers would be called. Wage garnishment agreements, which technically aren't enforceable without a court order, were signed. All asked for social insurance numbers, some for the names of friends. In one case, the lender called family members and hung up, just to make sure the numbers worked.

The people on the other side of the counter were friendly, incredibly so in some cases.

They depend upon repeat customers.

There would seem to be little for payday lenders to fear. Not from bad clients or the police, and not from government.

What they are afraid of, these days, are customers like Margaret Smith. And how they might play in front of a judge.

Harvey Strosberg strolls across his office overlooking the Detroit River and, with courtroom flair, plucks the note from a bulletin board and holds it in his thick fingers.

"You know, there's an interesting psalm," says Strosberg, of the Windsor law firm Sutts, Strosberg. "It reads, in part, as follows: ‘Yahweh, who has the right to enter your tent? The man whose way of life is blameless, who does no wrong to his fellow, stands by his pledge at any cost, does not ask interest on loans, and cannot be bribed to victimize the innocent’."

Strosberg pauses and looks up from the note, and the excerpts he's read from Psalm 15, Jerusalem Bible translation.

"This," says Strosberg, referring to the payday loan industry, "gives you the poster child for the people who aren't going to enter into heaven."

Margaret Smith is Strosberg's client and main signatory on a proposed $550 million class action against Money Mart and its U.S.-based parent company, the Dollar Financial Group.

Strosberg is, arguably, a master at finding poster children. He's one of Canada's top class-action lawyers. He helped to win $1.1 billion — the largest settlement in Canadian history — in the hepatitis C tainted-blood case. Lately, he's set his sights on the Criminal Code provision that sets out interest rate limits.

Smith's suit is one of at least eight proposed class actions in Canada alleging that payday lending companies charge criminal interest rates.

Though criminal charges have not been used to police payday lenders, the act that makes it an offence to charge high interest rates plays heavily in these suits, and in a number of recent civil cases.

Sandwiched between the crimes of extortion and breaking-and-entering in the Criminal Code of Canada is Section 347. It's the little-known, nearly never enforced law that makes it illegal to charge annual interest of more than 60 per cent.

As with the crime of treason, police and crown attorneys require ministerial approval to prosecute in such cases. Very few charges have been laid under the section. None dealt with payday lenders.

The section came into being in 1981, the brainchild of legislators who believed it would protect citizens from loan sharks. But it makes no distinction between a commercial loan and one taken out from the guy in the neighbourhood bar who collects with a baseball bat in hand.

Jacob Ziegel, a University of Toronto law professor who has followed Section 347 since its inception, believes it was fatally flawed from the outset.

"It's really pretty useless. If you're really concerned about loan sharks, it's a question of how to deal with those who want to use violence as collection methods.

"If you're concerned about protecting consumers, you need a much more sensitive and carefully articulated legislation."

Yet, for now, with little action from government, the Criminal Code is all there is.

In April, the Supreme Court of Canada ruled that late fees slapped on the bills of Enbridge Gas Distribution Inc. customers over the course of a decade amounted to "criminal misconduct." The court found that the fees, when calculated as interest, surpassed the criminal threshold of 60 per cent per annum. The utility has been ordered to make back payments.

In the same case, in an earlier, 1998 ruling, the court acknowledged it was bound by the Criminal Code, but noted that the law was "deeply problematic," and that some of its terms "are most comfortably understood in the narrow context of street-level loan sharking."

The court went on to say that Parliament must deal with the flawed law, which, to this day, it hasn't.

Whitelaw says there is some "nervousness" in the industry over the recent class actions.

"They are out there and we acknowledge that, but we are of the opinion that what's driving it is that section of the Criminal Code which did not foresee the advent of this business and the cost of a product for a short-term cash loan."

Whitelaw says users of payday loans know full well the cost of the loans they take out. "It's a service, and there is a cost of offering the product."

In other words, where's the harm?

Marty Doane, a Toronto lawyer with the Bay Street firm of Paliare Roland, says a law is a law and, even if it is flawed, in the case of payday lenders, it's being broken. His client, Toronto city sewer worker Ken Mortillaro, is taking on Cash Money and Unicash.

Doane sums up the payday industry's defence of its practices like this: "If someone elects to pay off a loan in a way that creates a criminal interest rate, then why should the lender be liable for that?"

"It's a stupid argument, as far as we're concerned," says Doane, "but we see it constantly. At the end of the day, if something's illegal under the Criminal Code, then it's illegal. These are paternalistic laws; they're meant to protect people from themselves.

"The people need that protection because they don't know what their rights are."

Rob Dowler's office sits 33 floors above the Eaton Centre — eye level with the big bank buildings on Bay St., and far removed from the strip malls where the payday lenders are thriving. Dowler is Ontario's acting assistant deputy minister in charge of policy and consumer protection, within the Ministry of Consumer and Business Services.

The province does not regulate nor license payday lending stores. The ministry has fielded 60,000 complaints in its consumer services bureau. Six were payday loan complaints. In the grand scheme of things, the industry is barely on the radar.

"In fact, I'm not aware of a lot of complaints being received by any consumer ministry across the country. I think some of the consumer groups have actually said there is a market, (that) some folks really appreciate the service these guys are offering," Dowler says.

New cost-of-credit legislation that will require financial institutions and other lenders in Ontario to be more transparent in the way they present credit offerings to consumers is coming. The province feels that should offer enough protection from less scrupulous lenders.

"As long as the service is offered correctly, so the consumers aren't hoodwinked, so that is clear up-front exactly what's being offered, people can vote with their feet," Dowler says. "Hopefully, the new regulation will help them go in with their eyes open."

That line of thinking doesn't sit well with payday critics, including MP Judy Wasylycia-Leis (Winnipeg North Centre). The New Democrat is pushing Ottawa to take action on the payday lending issue, but says government in general has taken a laissez-faire approach to consumer protection.

"I expect government … to care that there are snakes and leeches out there who are trying to take advantage of low-income, vulnerable people," says Wasylycia-Leis. "And that's the role of the state, to ensure that, in fact, you have fair interest rates for lending of money. A fair return for these outfits, but nothing that is exorbitant."

The issue of payday lending has made it on to the agenda of the Consumer Measures Committee, made up of representatives from Ottawa, the provinces and territories. It is looking at possible ways to regulate the industry and met in January, and again yesterday.

In the meantime, Bob Whitelaw says his association is developing a code of conduct for members and a new logo, based on the theme that the doors at payday lending stores are always open.

"I think customer service is key," says Whitelaw. "All you want to do is make (them) feel comfortable."

Margaret Smith sits in her living room wearing a Christmas sweatshirt that hangs off her tiny frame.

She talks of her upbringing in Scotland and move to Windsor when she was 18. Of her love for her late parents, Elvis and watching Law & Order on TV. Small talk helps.

She is, in a word, uncomfortable, and embarrassed to be sitting there, before two reporters, explaining how a single mother who was able to raise a son while holding down a job as a cleaner, and do so many of life's tasks on her own, lost control of her finances on a series of payday loans.

Her son eventually went on welfare, receiving $500 a month. "By the time he paid his rent and hydro, he had nothing. It was a bad situation, it was."

Made worse by the payday loans.

With help from her mother, Kim Elliott and her husband, Joe Doucet, paid off their outstanding payday debt with a bank loan this spring. The bank loan has an interest rate of 7.2 per cent. They didn't consider a bank loan in the beginning; they just needed $500, once, and payday lending all seemed so easy.

"I kick myself every time I think about it," says Elliott. "I don't want to see anyone get into that trap, I really don't, because they prey on people that don't have the means or any other way of survival."

Doucet and Elliott are involved in proposed class actions against several payday lenders, including Smith's case against Money Mart.

In May, Money Mart and its U.S. parent company filed a motion to dismiss the case. They are arguing that Smith signed paperwork that gives up her right to make a claim against them, and should instead enter into arbitration.

The case, and the others, could be years away from any conclusion.

Jasminka Kalajdzic, the lead lawyer on Smith's suit, says class actions, aside from recovering clients' money, are intended to modify behaviour and provide a voice for people who are not being heard.

"The type of people that are using this service, being targeted by these companies, are not the ones that go out there and protest. They're not the ones who have a political voice."

Smith would like to see the industry shut down all together. "I think we're being used, that's what I think.

"They know we need the money," Smith says. "It's like you leave something valuable behind. Pride was what I left behind."

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