How Common Is It For Debtors To Take Out Payday Loans, Or Fall Victim To Predatory Debt Settlement Companies Or Consolidators?

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Many conversations needlessly end up in heated disagreement simply because the participants don’t use vocabulary in the same way. Therefore, in order to answer the question posed, we need to establish some vocabulary.

1. Some Vocabulary
   1. Predatory Lenders A predatory lender is one who is unfair, deceptive, or fraudulent in loan origination, and who charges unreasonably high interest rates. The only difference between a predatory lender and a loan shark is that a predatory lender makes a pretense of operating within the law, whereas a loan shark flagrantly flouts the law.
   2. Predatory Debt Settlement Companies Predatory debt settlement companies target consumers with a lot of debt. They promise to negotiate on your behalf with your creditors to settle or reduce your debts. These companies frequently charge a large upfront fee for the services. The alleged humans at these companies go through a painful surgery to have their ethics and morality removed.

      I estimate that approximately ten percent of my clients have been in a scam predatory debt settlement program for a year or two, and call me because some of the creditors who were supposed to be dealt with in the program have filed suit against them. In sum, the program didn’t deal with their debts, and instead relieved them of the money they paid to the scam outfit.

2. Problems Understanding The Terms Of The Agreement – Interest Some people are roped into predatory loans, settlements, and consolidations with a shocking lack of understanding of the arrangement they entered into. I have had clients come into my office who literally had no understanding of the concept of interest, and therefore had no way of understanding the terms of the agreements they signed.

   For example, I had a man come in some time ago to talk about a title loan he had taken out on a car he fully owned and had already paid off. This means that he borrowed against the collateral of the car, which could then be seized if he didn’t pay off the loan.

   The loan was for $5,000, but the interest rate was outrageously high. When he came to my office, he had already paid $800 per month on the loan for three months, meaning he had already paid $2,400 on a $5,000. He told me that he therefore expected to have the loan paid off in a matter of months.

   However, when he showed me his most recent statement, it was clear that there was a problem. Even though he had made payments of $800 per month, the balance had actually increased to $5,500.

   The reason behind this apparently illogical result lies in the terms of the loan, specifically in the interest rate.

   Interest rates are charged by lenders to make lending profitable for them. They are tacked on to the actual sum of money you borrowed, ostensibly to make it worth the creditor’s while to offer the service of lending money.

   The other justification for interest has to do with inflation. High rates of inflation shrink the buying power of the dollar. If the rate of inflation rises steadily over a period of time, then the buying power of the dollar shrinks proportionally.

   As an example, let’s say a lender lends you $100, and a year later you pay the lender $100. If inflation rate for the year was 5%, the $100 that you paid the lender would have a buying power equivalent to $95 at the time you borrowed the money. Proponents of interest argue that interest is necessary simply to at least keep pace with inflation, let alone make a profit.

   This brings us to how interest rates are calculated. Generally, there are two types of interest rates: Simple Interest, and Compound Interest.

   1. Simple Interest is calculated as follows:Assuming the interest is calculated annually, at the end of the first year, multiply the original loan amount by the interest rate.

      For example, suppose the original loan was for $100 at 10% interest, and you made no payments the first year. Then at the end of the year the interest would be $10 (= $100 × 0.1), so the new loan balance would be $110 (= $100 + $10). If you made no payments during the second year, at the end of the year the interest would once again be $10 because it is calculated on the original loan amount rather than the new loan amount. Therefore, at the end of the second year the balance would be $120 (= $110 + $10).

   2. Compounded Interest is calculated by multiplying the interest rate by the current balance, rather than the original loan amount. How is that different from simple interest? A simple example will illustrate the difference.

      Although the compounding can be done more frequently, let’s assume for simplicity that the compounding is done once a year.

      And as before, let’s assume that the original loan was for $100 at 10% interest, and you made no payments the first year. Then at the end of the year the interest would be $10 (= $100 × 0.1), so the new loan balance would be $110 (= $100 + $10).

      If you made no payments during the second year, at the end of the year the interest would be $11 (= $110 × 0.1). rather than $10. Why? Because it is calculated on the current balance of $110, rather than the original balance $100. Therefore, at the end of the second year the balance would be $121 (= $110 + $11).

      Although I made simplifying assumptions to make the concept easier to grasp, this discussion captures the basic idea of interest calculation.

   3. Some Recent Interest History On the one hand, if Interest the interest rate is higher than the inflation rate, the creditor will make a profit lending money.

      On the other hand, if the interest rate is lower than the inflation rate, the creditor will have a loss if it lends money. For example, if the inflation rate is 5% and the creditor charges 3% in interest, the creditor actually loses 2% of the value of the loan. Therefore, as a rule, creditors are always going to charge more in interest than the inflation rate. Otherwise, there is no point in lending money.

      This reality is clearly illustrated by the economy in the late 1970s. Many readers may not have been alive in the late 1970’s. However, I was an adult then, and saw first-hand what sort of impact a high inflation rate can have on day-to-day life and financial law (both in the immediate short term and in the long-term).

      In the late 1970s, the economy was in shambles. Inflation was around 13%. This rapid devaluation of the dollar was particularly obvious when one went shopping. You’d buy some consumer good, and then a couple of weeks later price for the same item at the same store had a higher price.

      Also in the late 1970s, the states imposed limits on the interest rates that a bank or lender could charge. However, these antiusury laws were not uniform, but varied considerably from state to state.

      At that time, Minnesota had lowest maximum allowed interest rate, which was about 8%. Since this was a great deal lower than the 13% inflation rate, no lenders wanted to issue loans in Minnesota.

      A bank in Nebraska offered credit cards to Minnesota residents at Nebraska’s maximum allowable interest rate, was higher than Minnesota’s maximum rate. Minnesota refused to allow the bank to issue the cards, so the bank sued. The case went before the U.S. Supreme Court.

      Although Minnesota asked the Court to uphold its antiusury laws, in Marquette National Bank of Minneapolis v. First of Omaha Service Corp (1978), the Court held that the Uniform Bank Act permitted the bank to charge the rate allowed in the state in which it was incorporated.

      The first major bank to realize the significance of the holding was Citibank. It approached the state of South Dakota, which was still largely rural. It offered to set up its business headquarters in Sioux Falls, and bring business, money, and jobs to the state. However, Citibank had one request. They offered the deal on the condition that South Dakota abolish its antiusury laws.

      South Dakota accepted the deal and abolished its anti-usury laws, so Citibank set up shop and incorporated there. Since it was now a South Dakota company, and South Dakota had no antiusury laws, it could charge any interest rate it wanted — not just in South Dakota, but in all 50 states because of the Marquette holding.

      Other banks picked up on the significance of the Marquette holding, and worked to abolish the antiusury laws in other states such as Nevada and Illinois (formerly the land of Lincoln, but now called the land of corruption because four recent governors left office to go to prison). If you’ve ever wondered why you send your loan payments to Nevada, or Illinois, or South Dakota, that is the reason.

      In the 1980’s inflation dropped precipitously, and the economy prospered. Interest rates also dropped. However, the damage was already done, and antiusury protection laws are all but nonexistent. Lending entities that have incorporated in states with no antiusury laws can charge whatever interest rate they want, anywhere in the country. This is true when the economy is prospering, and people have a wider range of economic choices. However, it is also true when the economy is suffering, and they have less financial choice and more urgent financial needs.

3. Predatory Lenders, ReduxI exclude the main large banks (Citibank, Bank of America, etc.) from the somewhat emotionally charged term, predatory lender. Generally, those banks charge fairly reasonable interest rates when they lend money. However, there is one caveat: The interest rates on the credit cards they issue to people with less-than-ideal credit, are at loan shark levels.

   I think of predatory lenders as lenders who charge loan shark interest rates. These are rates that are too high in any context, under which the borrower doesn’t have a fair or reasonable chance of repaying the loan without incurring deceptive amounts of extra debt. These loans are usually for relatively small amounts — between around $2,500 to $5,000.

   One recurrent reason a borrower takes out a loan with a predatory interest rate is abysmal credit. The borrower may have defaulted on several financial obligations, so no credible lender with reasonable rates will lend that borrower anything.

   A borrower in this situation is desperate, and resorts to taking out loans with predatory, ultra-high interest rates (such as Payday or Cashcall loans). The unfortunate fact is the lender will always tack on a premium if it perceives the borrower to be high-risk. In fact, the kind of person who has to resort to a predatory lender is, almost by definition, high-risk. As a consequence, predatory lenders justify their exorbitant interest rates as protection against the high risk of default.

   A significant percentage of my clients have had this kind of loan. The interest rates are truly exorbitant and shock the conscience. The worst I’ve seen was in the case of a client who had a loan interest rate of 863.14% per annum. He really owed his soul to the company. I was shocked when I confirmed on the lender’s website that the rate was actually that high. This was some years ago, and lenders today don’t charge the same ultra-high rate; but the rates that are still offered by some of these lenders aren’t all that much lower.

   If you are in a situation where you are considering getting a loan with a predatory interest rate, don’t do it. Instead, scale back, wait a while, age the debts, and consider filing for bankruptcy protection. If you are taking out the money to buy something, don’t buy it. If you’re hungry, you should consider going to a food bank before taking out that kind of loan. Put simply, unless you discharge the debt in a bankruptcy case, these exploitative, predatory loans can haunt you for the rest of your life. Therefore, if you have this sort of debt you should seriously consider getting rid of it in a bankruptcy.

   If you do wind up paying off the whole loan, you will ultimately pay many times the original amount to the lender. You should never take them at their word when they say they aren’t charging exorbitant or predatory rates.

   The fact that this is a great deal for the lender may be enough to mollify its truly guilty conscience. But you have to live with the consequences.

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