Several states have passed legislation in recent months either outright banning or severely restricting payday loans. But why? Whose job is it to protect the consumer? The lender? The government? Or the consumer himself?

There may be no good answer, and for certain there’s no perfect answer to the question. On the one hand, even business should have some sense of moral obligation not to take undue advantage of consumers. And many would argue that rates that amount to 400% APR are certainly taking advantage of consumers.

On the other hand, borrowers who find themselves in a hard spot, with no money to pay for a needed bill and credit so bad even mom and dad won’t float them a loan have few other places to turn. And let’s face it, most of us have been in a tight spot once in a while, and needed some money before payday.

So, where does the government fit in? In some cases, state governments have decided that the payday loan industry is so bad, and charges such exorbitant rates that it needs to be shut down entirely. New Mexico is a great example. But is it helping?

These lenders still manage to find ways to lend money out at extreme interest rates. The only real difference is they use things like a car title as collateral instead of a check that lender and borrower both know would bounce over the Empire State Building if it were ever actually cashed.

Other states have gone to great lengths to make sure that borrowers are at least educated about the interest they are paying and given ways to get out of the hole if they find themselves in too deep. In Michigan, for example, borrowers have the right to request three month terms, in which they have three months, rather than until next payday, to pay off their loan.

There’s no perfect answer here. If you eliminate the payday lenders, borrowers find other (and sometimes worse) ways to borrow money. Or they do without loan money when they genuinely need it. Maybe the best answer would be if we could have a payday loan company offer 0% interest loans. No takers? Oh well, it was worth a shot.

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Let us say first of all that we know that our political leaders, for the most part, are trying to do what they believe is in your best interest. We get that. There are some people who, either because of their own poor choices or an unscrupulous lender, have become really tangled up in short term loans. We’re not contesting the need for reasonable measures aimed at helping such people.

Many states, Michigan being a notable example, have safety nets in place by which someone who finds themselves over their heads with payday loans, can pay the loans back over 3 months or more. This limits their ability to use short term loans for a while, but in general it helps them out of a bad situation. These kinds of programs are a good idea.

But what about states that are considering (or already have) eliminating the option of payday loans? What happens to the people of those states if their car breaks down and they don’t have the money to get it fixed? If they have poor credit, this eliminates their best way of getting to work and earning money. And if they can’t do that, how can they fix their credit? While payday loans do end up in a vicious circle for some, not allowing them can also be a bit of a Catch-22.

If you want to keep this option open for yourself and others, you need to let your voice be heard. Call or write your Senators and Congressmen and let them know what you think about it. And when you do, suggest that common sense regulations would make more sense than an outright ban. Otherwise, things could get even tougher for the people who genuinely need an occasional advance on their paycheck.

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It’s not difficult to dig up the laws in your state concerning payday loans. Check here for a state by state rundown of the current laws regarding payday loans. The regulations are explained in simple, layman’s terms that just about anyone who reads this article should be able to understand.

Many states have caps on how much interest lenders can charge, and several others have provisions which allow for borrowers to get out of the cycle of reloaning by choosing to pay the loan back over a set period of time, more like a traditional loan. Of course, some of the lending companies will refuse to lend to you again if you do this, and this is their right. But, at least it offers you the opportunity to get out of a bad situation before it really gets out of hand.

Some states have outright banned payday loans, and others are considering legislation to do so. You’ll have to decide whether or not you think that’s a good idea. Our take is that regulations and limitations are necessary to keep some semblance of fairness in the payday loan industry, but outright banning them can also be harmful to people who need them: mostly the working poor when they are faced with an emergency.

It’s never a good idea to take out a payday loan that you don’t absolutely need. While the companies will advertise the loans as a great way to pay for a vacation, have extra spending money, or any other number of frivolous uses, common sense will tell you that paying high interest rates on a short term loan is a really bad idea except in a genuine emergency

Even then, you should pay off the payday loan right away. If you can’t afford to pay off the payday loan in one payday, you should really ask yourself if this is truly a matter of life or death. And if it isn’t, skip the loan.

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How They Should Work

Done the right way, a payday loan can be an important stopgap for someone who hits an emergency with no way to pay for it between now and payday. A good example is when your car breaks down. If you’re like most people, you can’t get to work if your car won’t run. So, sucking it up and paying the high interest rates might be worth it to get your car back the same day so you don’t miss a lot of work. As long as you pay the loan off on pay day, it isn’t a big deal.

How They Usually Work in Reality

Too often, people borrow more than they’re going to be able to repay. Of course, not repaying it isn’t an option, so after you repay your loan, the company “re loans” you the money, less the interest, of course. With a typical $400 loan at 13% interest (a typical rate), you’re out $52. In some cases, clients keep re loaning the money over and over again. On the hypothetical $400 loan, re loaning will cost you almost $700 in a three month period, just in interest.

So, Should They Be Illegal?

The state or Arizona thinks so. Recently, legislation was passed in that state banning payday loans. And numerous other states have passed legislation heavily regulating the practice. In Michigan, payday loan agencies are required to give borrowers the option of paying their payday loans off in three monthly payments (though this may prevent future borrowing). But making them illegal takes away an important option for people who need the credit and don’t have other options.

So What Should Be Done?

We don’t claim to have all the answers on this. One thing the loan companies could do to police themselves is to stop promoting the loans as the answer for immediate gratification of things such as vacations and other desires that may be better put off if people can’t afford them. And whatever they do or don’t do, you can always manage your own affairs by refraining from using payday loans except when absolutely needed.

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A brief history

Colorado politicians have wanted to institute some form of payday loan reform. Representative Mark Ferrandion has been working on payday loan reform since he arrived in the Legislature three years ago.

Critics for the payday loan industry have fought long and hard to keep the current structure. Their arguments have primarily focused around the idea that a payday loan provides credit to people who cannot get a loan from a bank.

Supporters of this new bill have a different view on the payday loan industry. Supporters argued that payday loans feed on the poor with predatory practices. These practices include outlandish percentage rates and encouraging people to take more payday loans to pay off old payday loans.

The consequences of this new bill

Consequences of this new bill are already rolling in. Over the past weekend, at least six payday loan stores closed their doors. Many more payday lenders will follow suit. Many of these sources will close their door before the bill ever becomes law.

The reason for these closures is due to the repayment schedule on new loans. Payday loan stores will need a higher cash flow, as loans will not be turning over on a bi-weekly basis. Now these payday loan sources have to wait six months before the loans bring in money.

It is not all chocolate and gumdrops

House Bill 1351 might sound like a grand idea, but like all laws, there are some gotchas. First off, the current payday loan annual percentage rates can get as high as 400 percent. Under the new law, the maximum percentage rate a loan will have is 45 percent. This might sound great until you add in loan fee. These fees could push charges to over 100 percent of the original loan amount.

Do you remember that higher cash flow need from earlier? Payday loans could start seeing skyrocketing fees to help make up for that lack of cash flow. Payday loans make their money off high interest rates. With a cap on the interest rate, what will happen to the lending fees?

A little new and a little old

This new law goes in effect on August 11, 2010. Any new loans made at that time will have to follow the new interest and time frame guidelines. Any preexisting loans are still free to follow the current laws until next year.

Colorado is taking a bold move to change the payday loan industry. How this will all play out for businesses and consumers has yet to be fully determined. With six businesses already closing up shop and more to follow, is this truly a good deal? Better yet, what will this do to the industry across the country? What state will follow this example? Time will tell.

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Arizona’s Attorney General, for example, has gone after payday lenders on many occasions. There are other states, such as Illinois, that have passed a number of different measures aimed at shutting down payday lenders. Another state to recently pass payday loan restrictions was the state of Wisconsin. It seems like everywhere you turn, there are state politicians and legislators that want to put the screws to the payday loan industry.

There is even a federal law that dictates how payday lenders can loan to military personnel. The federal legislation aims to prevent abuse of military families by limiting the interest rate that the lenders can charge on a payday loan to those folks.

The latest state to take a stab at the often-controversial payday loan industry is Colorado. The Colorado House recently passed a measure onto that state’s Senate for consideration.

Currently, the maximum annual percentage rate that a lender of any type can charge in that state is 300 percent. The new legislation would dramatically reduce that rate down to an annual rate of just 45 percent.

According to the Attorney General in the state of Colorado, the average borrower of a payday loan renews and refinances that loan a total of five times before they pay off the original amount. That works out to be a hefty sum. In the year 2009, the average payday loan borrower in Colorado borrowed about $336.97, and paid a whopping $475.73 in interest on that loan.

Needless to say, those in the payday loan industry are carefully watching what’s happening in Colorado to see whether or not the legislation makes it any further.

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Wisconsin has recently passed legislation that is designed to combat the high interest loans provided by payday lenders. Proponents of the legislation argue that the high interest rates take advantage of the working poor, and that the rates are predatory.

Opponents of the legislation make their case based on free enterprise. They argue that there is a demand for short-term, low value loans in the marketplace, and that the only way for a company to make a short-term low value loan profitable is to charge what winds up being a high interest rate. They argue that the fees associated with a payday loan are relatively small when compared with fees for things like overdraft protection from a bank or a bounced check fee.

Unfortunately, there is speculation that this legislation won’t really solve the problem, and that the working poor will still be vulnerable to high-interest loans.

The problem with the legislation is that it doesn’t actually include any rate caps. Instead of limiting the fees that the lender can charge, it limits the amount that the borrower can borrow. The legislation caps the size of a payday loan at $1,500 or the equivalent of 35 percent of the family’s monthly income, whichever is lower. It would also allow borrowers to roll over their loan once.

The legislation also tries to reduce the number of payday loan businesses, as well as limit their locations. A payday lender would not be able to operate within 150 feet of a residential area, or within 1500 feet of another payday lender.

Up to this point, Wisconsin has been the only state to not put some regulation or another on their payday lenders. This particular legislation opens that door, although it does it in such a way that it may not have much of a beneficial impact on the folks who are taking out these loans to begin with.

What’s really screwed up about this is that, according to the L.A. Times, the agency wouldn’t even apply to some of the most controversial financial businesses in the country: payday lenders.

This is another example of lawmakers assuming that you’re a moron, suggesting that they can fix the problem, and then ignoring some of the most important and obvious parts of the problem.

We all know that payday lenders charge seriously high rates. Their rates are usually about ten times what any other form of credit has. Very few people who walk through the doors of a payday loan business do so under any illusion that they’re not going to be paying through the nose in interest.

Yet, they still do it. They want or need a quick way to get cash, and payday loans offer that kind of service. They offer that service to customers who have largely been forgotten by the major financial institutions and structures, which is why they can and do charge such high rates of interest.

At stake, as well, is the current way that payday lenders are regulated. Today, payday loans are governed under state law. That means that Arizona, for example, can take steps to essentially rid their state of payday lenders if they don’t want them. Another state can make it easier for them to operate.

Whether or not Washington ought to have a say in the matter is part of the bigger question. Folks who are opposed to payday loans, however, usually believe that they ought to be done away with everywhere, and so push for the kind of federal financial regulation and meddling we’re talking about here.

The issue surely isn’t going away, and it will be interesting to see what kind of progress, if any, payday loan opponents are able to make at a federal level. If they can’t seem to get the job done in Washington, they will most certainly head back to state capitals to try to get individual states to shut down payday loan businesses.

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This and other reasons have Colorado legislators considering passing regulatory legislation on payday loan companies in 2010. Proponents of this suggest:

• Once people enter this debt cycle, they often stay in it
• An estimated $80 million in excess fees is paid out by borrowers. This is money that could otherwise be supporting Colorado’s economy.
• In most cases the money goes to firm headquarters outside the state

Legislative Efforts

In 2008, Denver Democratic state Representative Mark Ferrandino, attempted to introduce legislation that would have limited the worst abuses. However, he wasn’t able to introduce the legislation.

Representative Ferrandino said he is considering making another run at it this year. He indicated that he’s working with some local consumer advocate groups to put together some legislation but is still uncertain whether or not he’ll proceed.

“I am up against a very strong lobbying core and they have a lot of money and a lot of influence down here. They have the ability to take any bill that is moving forward and shape it to their own interests and really stop any real reform. I want to make sure I have my ducks in a row before I go ahead on this,” said Ferrandino.

Other groups are working on legislation to impose a 36 percent rate cap on payday loans.

Another approach is to try and take it to the people to vote on the legislation as a referendum. This would avoid lobbyist pressures.   Plus, the polls on it are favorable and strongly supported by Democrats and Republicans.

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Take, for example, the issue of payday loans. Back in 2007, the government decided that it should step in and prevent what it perceived to be an abuse of the nation’s servicemen and women. They passed a law that forbid any lender in the United States from charging more than 36 percent interest on a debt to a person in the military or their family.

Ostensibly, this law was designed to protect soldiers from payday lenders.

Some states have also passed laws that create a similar situation for all of the citizens in their state. Oregon, for example, has a 36 percent cap on interest rates. Groups like the Service Employees International Union have lobbied for these laws, claiming that the practices of payday lenders are predatory.

Proponents of these laws point out that banks and credit unions make plenty of money lending money for rates far below those of payday lenders. The problem comes with the term of the loan. While a bank loan is typically going to last a year or more, a payday loan usually lasts about two weeks.

This means that, even if the rate were capped at 90 percent, a payday lender would be able to only charge about 10 cents a day per $100 of the loan. That works out to $1.40 over a two week period. As the average payday loan is less than $300, this would make it completely unprofitable to try to run a business.

The problem with these laws is that they effectively protect only a small minority. Most people who walk into a payday lender understand that the interest rates are high, but they’re willing to pay them because of the extremely short term of the loan. To be able to borrow $100 at a fee of $15 in order to be sure that you don’t bounce a check and pay as much as $35 to your bank and another $35 to the recipient of the check makes good sense. Unfortunately, these laws block soldiers all across the country and citizens of many states from having that option.

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