This article was supervised by MinnPost journalist Sharon Schmickle, produced in partnership with students at the University of Minnesota School of Journalism and Mass Communication, and is one in a series of occasional articles funded by a grant from the Northwest Area Foundation.
Let’s say your car broke down, and you need quick cash to pay the repair bill.
If you were in Missouri, you could turn to a payday loan shop. But it would cost you plenty. State lenders can charge up to $75 for every $100 borrowed — which is close to a 1,950 annualized percentage rate, the common guide for measuring interest.
If you were in Arizona, though, you’d have to look elsewhere for a fix. Out of concern that predatory lenders were gouging consumers, Arizona and several other states have outlawed payday lending outright or else set low limits for interest rates and loan amounts. Some never legalized that form of lending in the first place.
Those two examples define the bookends for the range of state payday lending regulations across the United States. Minnesota sits in the middle of that range, not the strictest state by any means, but not as lenient as many others.
Consumer advocates and some state lawmakers say the middle isn’t good enough for Minnesota, a state that has led high-profile crackdowns on consumer fraud over the years and also passed laws protecting consumers from false advertising, high-pressure sales pitches and a long list of other questionable practices.
“Minnesota used to be one of the most consumer-friendly states but I don’t think we’re anywhere near that anymore,” said state Sen. John Marty, DFL-Roseville, a legislator who has signed onto several bills in the past that would tighten payday lending regulations in the state.
“We’re not a leader in this for sure,” he said.
Permissive to restrictive
Nearly every state has some regulation on high-interest, short-term loans, or payday loans. But borrowers can get a much better deal in some states than in others.
Beyond the terms of the loans, tough state regulations also prompt significant numbers of borrowers to turn away from payday lenders and seek other solutions to cash needs, according to a 2012 report by Pew Charitable Trusts.
Pew researchers placed 28 states into the category of what it defines as “permissive,” including seven states that set no interest limits at all on payday loans. Eight, including Minnesota, are considered “hybrids,” or states that allow payday storefronts to operate but limit fees and amounts that can be borrowed. Fifteen, including Washington D.C., ranked as “restrictive” states where payday loan storefronts don’t exist, although some payday lenders operate online often in violation of state laws.
Borrowing was far lower in restrictive states, the Pew researchers concluded. For example, just 2 percent of the people surveyed in Massachusetts and 1 percent of those in Connecticut (restrictive states) borrowed from payday lenders, compared with 4 percent in Minnesota (a hybrid state).
In a more recent installment of a series of studies called Payday Lending in America, Pew summarized the reasons regulators worry at all about payday lending:
- Fifty-eight percent of payday loan borrowers have trouble meeting monthly expenses at least half the time.
- Only 14 percent of borrowers can afford enough out of their monthly budgets to repay an average payday loan.
- The choice to use payday loans is largely driven by unrealistic expectations and by desperation.
- Payday loans do not eliminate overdraft risk, and for 27 percent of borrowers, they directly cause checking account overdrafts.
- Forty-one percent of borrowers have needed a cash infusion to pay off a payday loan.
By almost a 3-to-1 margin, borrowers themselves favored more regulation of payday loans, Pew reported.
And so, it is no wonder that payday lending is a nearly perennial issue in legislative chambers across the United States. According to a 2009 report from the Better Business Bureau’s chapters in Missouri, hundreds of bills have been introduced in Congress and in states nationwide to limit or stop payday lending.
“More and more states are clamping down on the payday loan industry with legislation that either bans payday lending entirely or provides stiff regulation of the industry,” the report said.
Not easy to compare
Saying that Minnesota fits somewhere in the middle of the regulatory spectrum is far from telling the whole story.
Straightforward comparisons of Minnesota with other states are difficult. Under Minnesota law, payday loans are supposed to be limited to no more than $350 with a maximum fee of $26. But most payday lending works through a legal loophole allowing loan amounts up to $1,000 with fees that amount to annualized interest rates well over 200 percent. (More information is available at this installment of MinnPost’s Lending Trap series.)
Meanwhile, other states have taken various approaches to regulating payday lenders, often with complex results. Thirty-eight states allow payday lending, for example, but in some of those states the practice is virtually impossible because of recently imposed usury limits.
Here is a closer look at the situation in selected states:
Among states where payday loan rates are regulated, Missouri allows the highest APR. At 75 percent of the initial loan, a two-week payday loan can come with a 1,950 APR.
But most lenders don’t charge the maximum. The average APR in the state in 2011 and 2012 was about 455 percent, or about $53 in interest and fees for an average $300 two-week loan, according to a 2013 Missouri Division of Finance report to the state’s governor.
Even so, average interest rates in the state have risen steadily, from 408 percent in 2005 to the current 455 APR. Likewise, the average loan amount has increased from $241 to $306.
The demand for larger loans is mirrored in other states, including Minnesota where the loan size increased from $316 in 2005 to $373 in 2011. At storefronts in Minnesota, customers can borrow up to $1,000, although many businesses won’t lend more than $500.
But Minnesota’s rates tend to be lower than those charged in Missouri. Minnesota borrowers paid fees, interest and other charges that add up to the equivalent of average annual interest rates of 237 percent in 2011, according to data compiled from records at the Minnesota Department of Commerce. The highest effective rate in Minnesota was 1,368 percent, still lower than Missouri’s cap of 1,950 percent.
Timeline of significant events in regulatory history of short-term loans
1916: To combat loan sharks, the Russell Sage Foundation publishes the Uniform Small Loan Law — a model law for state regulation of loans of up to $300 at 3.5 percent monthly interest. Two-thirds of states eventually adopt some form of this law, allowing Annualized Percentage Rates of 18 to 42 percent.
1939: Minnesota passes the Small Loan Act, based on a later draft of the Uniform Small Loan Law — which allows for loans up to $300 and 3 percent monthly interest.
Early 1990s: State legislatures begin allowing deferred presentment transactions (loans made against a post-dated check) and triple-digit APRs — today known as payday loans.
1995: Minnesota passes the Consumer Small Loan Act, which allows short-term loans up to $350 and fees and interest equaling no more than about $26.
2001: North Carolina allows its payday lending law to expire, making payday loans illegal again after being allowed for four years. It is the first state to ban the loans after legalizing them.
Early 2000s: Some Minnesota lenders begin operating as Industrial Loan and Thrifts, allowing them to grant larger loans and charge rates beyond the 1995 Consumer Small Loan Act.
2006: Congress passes the Military Lending Act of 2007, which prohibits giving out payday loans, vehicle title loans, and tax refund anticipation loans at an APR of more than 36 percent to military personnel and their families. It’s the only federal regulation on payday lending.
2008/2009: Legislation is introduced to further regulate Minnesota’s payday loan industry, including capping the APR at 36 percent. Despite support from consumer advocates, bills still make little progress in the face of strong opposition.
2013: Fifteen states do not allow payday loan stores or else set interest rate caps low enough to drive payday lenders from the state.
2013: Minnesota lenders operating as Industrial Thrift and Loans now dominate the market. The top three small-loan lenders in the state are licensed as Industrial Loan and Thrifts.
Sources: Pew Charitable Trust, Minnesota Legislature, Center for Responsible Lending, “A regulatory small loan law solves loan shark problem” J.A.A. Burnquist, The Center for Responsible Lending
While Missouri stands out, some of Minnesota’s next-door neighbors also are “permissive” states, according to Pew’s research.
Wisconsin and South Dakota don’t cap the interest rate on payday loans. In Wisconsin lenders cannot give out more than $1,500, in South Dakota it’s limited to $500.
The average APR on a Wisconsin payday loan in 2012 was 584 percent, according to the state’s Department of Financial Institutions, or about $90 on a $400, two-week loan.
Another issue regulators consider is “rollover,” the practice of taking out a new loan to pay off fees and interest on a previous loan. The Pew researchers found that only 14 percent of payday borrowers can afford the more than $400 needed to pay off the full amount of a payday loan and fees. So many borrowers renew the loans rather than repaying them. Ultimately, nearly half need outside help to get on top of the loans, and they turn to the same options they could have used instead of the payday loan: seeking help from friends or family, selling or pawning personal possessions or finding a different type of loan.
Missouri, like a few other states, allows borrowers to rollover up to six times.
Minnesota and many other states ban rollovers but customers can take out the same loan as soon as the first is repaid. In 2011, nearly a quarter of Minnesota borrowers took out 15 or more payday loans, according to the state Department of Commerce.
On New Year’s Day, a new law took effect in Delaware, limiting borrowers to five payday loans a year, including rollovers and regardless of lender.
Advocates in Delaware had pushed for years to outlaw payday lending but failed. The new law represents a different approach, one that some other states are taking too: reducing rollovers but not eliminating high-interest, short-term lending.
Delaware’s move started with unlikely collaborators.
Delaware state Sen. Colin Bonini — a Republican who said he is “as conservative and pro-business as you can get” — teamed up with Delaware Community Investment Action Council, other nonprofits and Democratic state Rep. Coleen Keely, who wanted to ban the practice.
Bonini said in a telephone interview with MinnPost that he had been personally affected by payday lending when a relative got caught up in a “debt trap.”
While joining forces with advocates for outright bans, Bonini argued for a different approach.
“Under no circumstances did we want to get rid of the loans, because they’re very important for people to have access to credit,” Bonini said.
Instead, he stressed that the target should be the “debt cycle” — perpetually taking out loans, one after the other.
“So we hopefully created a system where people can still get access to a loan they need but won’t get caught up in seven or eight or nine of these,” he said.
Before the bill, Delaware had relatively light restrictions on payday lending. Consumers could borrow up to $500 without an interest rate cap. The new law raised the loan cap to $1,000 but didn’t cap the interest rate, something Bonini said was not as great a worry as the number of loans per borrower.
In Minnesota, similar bills to curb lending practices have regularly been introduced over the years.
In 2009, state Sen. Kevin Dahle, DFL-Northfield, proposed allowing up to three payday loans in a six-month period, with a fourth loan being automatically paid back in installments. He said that the idea faced strong opposition and made little headway.
Some Minnesota advocates for stricter regulation agree with Bonini that payday lending serves an otherwise unmet need for short-term credit.
“At this point, given that the traditional finance system has not stepped up to fill the gap or offer comparable products on better terms, I don’t know that we outlaw it,” said state Rep. Jim Davnie, DFL-Minneapolis, who has been a leading proponent of tougher regulations in Minnesota.
In Montana, nearly 72 percent of voters in 2010 approved a ballot initiative to cap interest rates in the state at 36 percent APR.
Several earlier attempts to regulate the lending had been thwarted in the state Legislature, said Nicole Rush, communications director for the Montana Community Foundation, which worked with a statewide coalition on the ballot initiative.
“We just faced too much opposition from industry lobbyists,” she said.
Industry lobbyists in Minnesota have similarly opposed any changes to the state’s laws. Brad Rixmann, owner and CEO of Payday America, the largest payday lender in Minnesota, gave more than $150,000 in campaign contributions in 2011 and 2010 combined. (For more information, see this installment of MinnPost’s Lending Trap series.)
And just like Minnesota, Rush said Montana’s opposition was bipartisan. Although DFLers have tended to push regulation in Minnesota, they’ve faced strong pushback from within their own party as well as from Republicans.
Lacking success in the Legislature, Montana’s advocates for stricter regulation turned to the public. A few public opinion polls had indicated there was support for an interest rate cap, Rush said.
Although Montana’s new policy is not an outright ban, Rush said payday lenders have shut their doors since the initiative passed. Nationwide, payday lending supporters and opponents agree a 36 percent cap effectively bans payday loans. But Rush said she hasn’t heard much outcry for short-term cash.
Montana has a strong libertarian streak. It is one of a few states without a sales tax. But Rush attributed the APR cap to citizens being “conscious of corruption.”
As states evaluate payday lending regulations, a relatively new federal agency also is looking into the short-term credit market. In mid-February an advisory board to the Consumer Financial Protection Bureau urged the board to consider rule changes.
“There is an obvious demand for short-term credit products, which can be helpful for consumers who use them responsibly and which are structured to facilitate repayment,” Richard Cordroy, the bureau’s director, said in a statement. “We want to make sure that consumers can get the credit they need without jeopardizing or undermining their finances.”
“Debt traps should not be part of their financial futures,” he said.
In Minnesota, Dahle, the DFL senator from Northfield, said he plans to revisit the issue. He said he has support from religious groups as well as from some fellow legislators. In keeping with their missions to serve the needy, many faith-based groups have become advocates for disadvantaged borrowers.
Dahle said he’ll look over the issue after the current session ends and formally bring it up again in 2014.
“There’s a lot of allies with me on this,” he said.