Any rational observer would wonder, how is that legal?
History tells the story.
In the early 1900s, the state was rife with loan sharking. Scurrilous characters preyed on vulnerable Alabamians with scant access to the credit market. Poor whites and disenfranchised blacks were especially vulnerable.
That started to change when John Patterson took office, first as attorney general in the early 1950s, then as governor in 1958. Patterson started cleaning up the problem and worked to open legitimate credit to the working poor.
With Patterson championing it, the Small Loan Act was passed in 1959. Limiting small loans to a few hundred dollars, the legislation aimed to (a.) encourage lending to low-income earners and (b.) prevent exploitation. As the law took hold, it eventually sparked competition among legitimate lenders and in time worked to further strangle the remaining loan sharking operations.
But with a series of alterations in the 1970s, 1990s and this decade, the rules governing small loans drifted away from Patterson's twofold goals of opening credit to the poor and protecting them from crippling indebtedness.
Payday lenders, going by the fancy names of "deferred presentment" or "deferred deposit services," found a loophole that allowed them to operate outside of the Small Loan law, which caps annual interest rates at 36 percent.
The last vestige of Patterson's dream was vanquished in 2003, when the state Legislature introduced regulations for payday lending under the Deferred Presentment Act. The Legislature exempted payday lenders from the traditional usury laws, allowing for interest rates equivalent to 456 percent annually. The law also prohibited lenders from loaning more than $500 at a time to one borrower, but neglected to set up a central database to track loans. Without such a database, a borrower can go to numerous stores, taking out cash advances.
Tom Keith, an attorney with Legal Services in Huntsville, draws a picture of the problem with a client of his who wishes to remain unnamed.
She owns a modest home and is on Social Security disability income of $792 per month. "She made a single payday loan some two years ago," Keith wrote via e-mail. "Every month since, she was paying only the interest and renewing that loan, in part by taking out more and more payday loans, with more and more post-dated checks.
"She now has eight different payday loans alone, with a total of approximately $2,200 principal outstanding, plus as much as 456.25 percent interest on each. Although she seems to have repaid the principal of several of them many times over by now, she still owes the entire balance originally borrowed on each."
This, Keith argues, shows how the $500 limit on total liability for such loans is ineffective, and illustrates that the limits on renewals of loans are ignored or bypassed.
Keith is troubled. He says payday lenders are dodging the flimsy state laws, and in the process violating federal laws because the loans are tied to Social Security income.
Though his client has since closed her bank account, restricting the payday lender's direct access to her regular Social Security checks, the lender is still, as Keith puts it, inviting her to "bring them the money or just pay the $35 interest for a new loan to be able to get money back 'to help her get out of debt.' "
When asked his opinion of the current state of usury laws in Alabama, 84-year-old John Patterson recently expressed regret for how his reforms have fallen by the wayside, put aside by legislators who have forgotten the reasons state government stepped in to protect the poor from financial predators.
How a payday loan works
A mother needs $500 for, let's say, rent. She has a steady job, but won't be paid for another two weeks. An incident has occurred in the family, an unforeseen circumstance that quickly drained the checking account soon after the last payday.
The family has few assets, and many bills. Neither father nor mother qualify for a loan from a traditional bank. Extended family and friends are in no condition to help. So they turn to a payday lender located in a storefront on Quintard Avenue.
The couple walks in without an appointment and executes a contract with the payday lender. All that's needed to qualify for the loan is proof of income — either a paying job or government benefits — and a checking account. In return for advancing the $500, the contract calls for the repayment in two weeks of the entire principal, plus $87 interest and fees. (Most states, including Alabama, limit loans to two weeks.) The mother writes a postdated check for $587, and the business holds the check until the next payday.
And what happens if, in two weeks, the family still comes up short? Well, they could let the check bounce — or they could take out another payday loan.
If you were to calculate this loan out over 12 months, it would carry the equivalent of 456 percent interest.
The payday lending industry quibbles with this explainer, arguing that because the loans are limited to two weeks, 456 percent is misleading.
But as Leslie Parrish in the Washington office of the Center for Responsible Lending argues, reporting payday loan rates annually — as is required by the federal Truth in Lending Act — is the only way for consumers, lawmakers and policymakers to compare all loans. "This makes it an apples-to-apples comparison, not apples-to-oranges," she says.
Steve Graves, a professor of geography at California State University, Northridge, and co-author of the Catholic University Law Review article, puts it like this: "If you get pulled over by a state trooper for doing 80 in a 20-mph school zone, are you going to argue with the trooper that you weren't really speeding because you hadn't been driving for an hour? Just try that on a cop and see how far you get."