Makin' Money

The poverty-debt trap

Chris Farrell Mar 12, 2011

As a follow up to the Marketplace Money story on lending to high-risk borrowers, including immigrants, we turn to Webb Brewer. The former head of legal services in Memphis, Tennessee, he’s now a partner in the law firm of Brewer & Barlow. He has dealt with the trauma predatory lending for more than a decade and has led efforts to reform consumer lending laws. Problem is, the story of Memphis and the blight of poverty and debt isn’t unique to the city. It’s true around the country.

Nineteen states including Tennessee allow auto title pledge lending and have a payday lending statute that permits small loans at an annual percentage rate of 459%. (Several years ago Congress prohibited both kinds of loans to military families.)

What does this mean in practice? Take Tennessee’s auto title pledge law. It allows lenders to make loans, secured by the title to the borrower’s car, for up to $2,500. These loans purport to be for only thirty days; however, they automatically “roll over” for another thirty- day period if the loan is not paid within the first month. The borrower must pay 22% of the loan amount each time the loan rolls over, which translates to an annual percentage rate of 264%. If a borrower is not able to repay a $2,500 loan within a month (s)he will have to pay $550 as the cost of credit each month or her car will be repossessed. This creates a debt trap in which the borrower can pay well over $10,000 for a loan of $2,500 and still lose her vehicle.

The Tennessee payday lending law allows a lender to make a loan of up to $500 for a maximum of fourteen days secured by a post-dated check. Although there are limits on the number of loans and the aggregate loan amount per borrower, these limits are not policed and borrowers are routinely coached to lie to circumvent these limitations.

Reliable research shows that payday loans push families on the fringe of the middle class into poverty. On average, a borrower pays about $50 each payday for a $300 loan. The typical payday loan borrower takes out between eight and twelve loans per year and 87% of repeat loans are made before the borrower makes it to the next payday.

Desperation drives this industry. Most borrowers know these are bad loans but are facing some catastrophic event like disconnection of utilities or foreclosure. Memphis is one of the nation’s poorest cities. It is not surprising then that there are several hundred payday and title pledge shops in Memphis. The vast majority of them are located in African-American and Hispanic neighborhoods.

To illustrate the size of the predatory consumer lending industry, the state Department of Financial Institutions regulates 266 banks and credit unions and 2,069 payday and title pledge businesses. Memphis has long been called the “bankruptcy capitol” because of the high incidence of consumer filings. The prevalence of title pledge and payday lenders in the community, and the hopeless debt trap they leave behind, significantly contributes to the problem in Memphis–and elsewhere..

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