Rebuild credit with secured credit cards. (Photo Credit: CC BY-ND/Secured Credit Cards)

When it’s time to apply for a car loan or home mortgage, it helps to have a good credit score. However, all is not lost for those whose consumer credit history has seen better days. Although it can be expensive, using a secured credit card with an initial deposit requirement can help rebuild a credit rating so that large-scale loans are no longer out of reach. Here are some things to consider before applying for a secured credit card.

Know how secured credit cards work

In order to apply for a secured credit card, have an active savings account to serve as collateral for purchases. Generally, the credit limit on the secured credit card will be the money held in savings, although it can be a smaller amount. The card issuer will only take money out if you’re 30 to 60 days delinquent. Once bills on the secured credit card are paid on time for six months to a year, the credit score may have recovered enough to where unsecured credit card options that require no upfront collateral become available.

Issuer must report to the credit bureaus

If the issuer of your secured credit card doesn’t file with the major credit bureaus, the card can’t help you. Showing that you can make payments on time is essential for rebuilding your credit score. Keep in mind that a secured credit card will have an interest rate and grace period, so it pays to shop around for the best terms. Bankrate.com is great for comparison shopping. If you have a savings account that earns interest to go with your optimal-rate card, you’ll be on the road to credit repair.

Watch the fees and spending

Two major but often unavoidable drawbacks to secured credit cards are upfront and annual fees. Ideally, you won’t need a secured credit card for long, so the annual fee won’t hurt much, but the upfront fees can exceed $100 or more. Minimal or no upfront fee is best, but one’s eligibility for such a card will depend upon his or her credit rating.

In terms of usage, try not to use a secured credit card more than you can handle each month. Your goal should be to pay the balance in full monthly and keep total spending at less than 30 percent of the credit limit.

Sources

Bankrate

FOX Business

Rebuilding credit can be an expensive path

Do you live in one of the top 10 most credit card debt-ridden cities? (Photo Credit: CC BY/MoneyBlogNewz/Flickr)

Credit-card-wielding consumers have found that old habits die hard. That’s why it comes as no surprise that a recent study by credit reporting agency Equifax states that the U.S. is buried $790 billion deep in credit card debt. Broken down by city, here are the top 10 most credit card debt-ridden cities.

10. Winston-Salem, N.C.

On average, credit card debt per household is a robust $6,505. As the median household income is $42,869, the percent of annual income owed to credit card companies is 15.17 percent. Imagine what could have been accomplished with payday loans, rather than high-interest revolving debt that most people nurse along with monthly minimum payments.

9. Fayetteville, N.C.

One of four N.C. cities on this list, Fayetteville has 126,723 households that owe $6,519 per household on credit cards. A sizable percentage (15.34 percent) of median annual income – $42,506 – is paid in attempt to eliminate that credit card debt. With short term loans with a two-week maturity cycle, a great deal of interest debt could have been avoided.

8. Youngstown-Warren-Boardman, Ohio/Penn.

Median income here is lower – $39,304 – but so is the average household credit card debt: $6,142. However, that’s still 15.63 percent of the annual income on credit card debt alone. That’s about $1.4 billion in total debt, citywide.

7. Pensacola-Ferry Pass-Brent, Fla.

The 170,817 households in the Pensacola area owe $6,649 each to credit card companies, 15.79 percent of the median household income, $42,106. With personal loans, there would have been no cycle of debt.

6. Asheville, N.C.

North Carolina has heavy anti-payday loan legislation in place, so the credit card debt comes as no shock. Households owe 16.12 percent of annual income.

5. El Paso, Texas

Average credit card debt is lower at $5,349. That’s still 16.15 percent of annual income in El Paso, though.

4. Duluth, Minn.

Median household income: $38,392

Percent owed on credit cards: 16.72 percent

3. Toledo, Ohio

Another state that makes payday lending impossible, Toledo households owe 16.72 percent of annual income on credit cards. If payday lenders were allowed to operate at market rate in Ohio, hitting that percentage would be nearly impossible.

2. Canton-Massillon, Ohio

Median income: $40,912

Percent owed: 17.23 percent

1. Wilmington, N.C.

Households earn $42,392, but owe 17.26 percent on credit cards.

Sources

About.com

Yahoo Finance

‘I’m going to come steal your toys because your mommy didn’t pay her Discover bill’

When it comes to an even-handed approach to consumer lending like payday loans, in Elizabeth Warren we trust. (Photo Credit: CC BY-ND/robertj1954/The Right Spin for Americans)

Elizabeth Warren, Harvard law professor and chair of the Obama administration’s Consumer Financial Protection Bureau, isn’t a fan of hidden charges or complicated consumer credit agreements. Thanks to the reform introduced by the Dodd-Frank Act, Warren’s charge starting July 21 will be policing credit cards, banks, mortgages and non-traditional consumer credit products like payday loans — if she is named the permanent head of the CFPB. In a recent Associated Press interview, Warren underscored the need for simplicity in the consumer credit market.

Credit cards and the need for full disclosure

Elizabeth Warren pointed to the elephantine length of credit card agreements today. The font is tiny and the legal verbiage fills too many pages. Yet within such agreements, there are terms that can make or break a consumer’s finances. “Clearing out the shrubbery” is something Warren wants for U.S. consumers, and this may include improvements in the Schumer box on credit card literature that includes the APR and other periodic information.

Regulating the payday lending industry

For those underserved by the traditional banking system, Warren says that the CFPB will ensure that those consumers will continue to have access to payday loans and will not be taken advantage of. Destroying the payday lending industry isn’t on the agenda, as the alternatives can be dangerous.

“It can force people into unregulated markets, including ‘Jimmy the Leg Breaker,’ which is not where we want people to be,” Warren told the AP.

So long as the terms of a loan are spelled out clearly up front and the consumer is fully informed by the lender as required by law, the payday loan business is as legitimate as any other federally regulated consumer credit.

Small loans where the need is greatest

Extending the kind of short term loans consumers demand into areas that have not been well-served is another issue that will be on Elizabeth Warren’s agenda when the CFPB comes into power on July 21. Warren sees smaller community banks filling the role in part, but payday loan businesses also fit the bill.

Ultimately, great change is predicted in the ways that financial institutions interact with consumers. Warren sees changes coming in terms of online banking, expansions and added security. The way that lenders offer their services to customers will continue to change radically from the traditional model.

Sources

Associated Press

Payday Pundit

Elizabeth Warren on problems with U.S. banking system

Credit cards were not among the forms of consumer credit that increased in November. (Photo Credit: CC BY-SA/Colin/Flickr)

Bloomberg reports that consumer credit rose for the second straight month in November, a sign that consumer confidence may be on the rise. The $1.3 billion November increase in consumer lending, paced by government-held student loans, followed a $7 billion increase in October.

Consumer credit increased in auto, education fields

Non-revolving loans such as auto loans and student loans were up by $5.6 billion, according to November figures. Revolving consumer credit continued its 27-month nosedive by falling $4.2 billion, which indicates that maintaining high interest debt over time is becoming less attractive to U.S. consumers. It also means that even though consumer confidence may be increasing, times when emergency cash is needed still lend themselves to products like payday loans rather than credit cards.

Positive economic signs, with more to come

Theresa Chen, a Barclays Capital Inc. economist in New York, reportedly told her clients that the road ahead will be long.

“Consumer credit is still rebounding off the bottom. This is broadly in line with the rise in household spending that we have already seen over the past few quarters,” she said.

Even though a full recovery is far away, November’s $1.3 billion consumer credit increase still outpaced the $500 million recovery many economists forecast for the month. This pleasant surprise, along with a larger than expected U.S. jobs increase and unemployment rate decrease to 9.4 percent, helped bolster the Standard & Poor’s 500 Index. The S & P 500 ended 2010 with a 13 percent gain.

November auto sales another positive sign

The November consumer credit increase translated into another good month of sales for the automotive industry. According to Bloomberg, auto sales hit a seasonally adjusted 12.26 million annual rate in November, followed by a further increase to 12.53 pace in December. Combined, the 37.04 million rate for the final quarter of 2010 was the strongest the auto industry has seen since 2008′s third quarter.

Sources

Bloomberg

Consumer groups want the British government to crack down on payday lenders. (Photo Credit: CC BY/Andrew Magill/Flickr)

Groups such as the Consumer Credit Counseling Service (CCCS) and campaign organizations such as End Legal Loan Sharking are pressuring the British government to crack down on the short-term consumer credit market, reports This is Money U.K. A lower interest rate cap on “doorstep lenders and payday loan firms” is currently being pursued in proposed legislation. While these loans may be legal, argues End Legal Loan Sharking, the rate charged to high-risk consumers is far from reasonable.

Legal loan sharking is not payday lending

The mainstream media and consumer interest groups such as End Legal Loan Sharking tend to place payday loans and loan sharking into the same boat. That is the same mistake politically motivated consumer groups make in the U.S. The payday loan industry is governed by numerous legislative bodies in the U.K., notes Payday Loan Advances. The British Cheque Cashers Association (BCCA) and Insolvency Practitioner’s Association (IPA) regulate the function of payday loan companies in the United Kingdom. Thus, when compared with loan sharking, such payday loan features as APR are more highly regulated.

No fees are good fees, argues the establishment

According to End Legal Loan Sharking’s figures, “loan sharks” can charge as much as £82 ($132) in interest and fees for every £100 ($160) borrowed. What This is Money fails to report is that such loans are typically offered at high risk to the payday lending organization. Hence, protection must be built in.

Instituting a ‘Ten Minute Rule’

Labour MP Stella Creasy has championed a Ten Minute Rule that will reach British Parliament on Wednesday. The rule is designed to open up the U.K. consumer credit market, giving even those consumers with less than perfect credit access to affordable credit. It’s called a Ten Minute Rule because the supporter has 10 minutes to make the case for the bill in question.

“The Government needs to understand action is needed now to address the high cost of lending which exploits some of the poorest people in our communities who can least afford the charges door step lenders set,” Creasy told the British media.

The proposed Ten Minute Rule would cap payday lending APRs and fees. It would also empower local authorities to restrict payday loan business licenses and expand consumer access to credit union loans.

Sources

Payday Loan Advances UK

This is Money UK

A low average return on savings could make debt reduction pay off more, but people can't ignore their emergency fund. Image: Thinkstock

In these uncertain economic times, should a person try saving money or reducing credit card debt? With the average return on savings in the U.S. so low, many financial experts say that consumers will come out ahead in the long run with debt reduction. Basically, the cost of carrying credit card debt outweighs the benefits of saving money. Americans as a whole agree, as consumer credit is experiencing its deepest decline in history. This is good for individuals trying to regain their financial footing. But massive cutbacks in consumer spending are hurting the economy as a whole. The result is an environment that makes saving for an emergency fund in lieu of debt reduction a good idea.

Low interest rates favor debt reduction

Record-low interest rates could mean that debt reduction will pay off bigger for the time being than bolstering an emergency fund. Peak Personal Finance reports that low rates mean cash saved in an emergency fund yield less. It is likely people  will benefit more by paying down high interest debt than putting money into a so-called “high yield” savings account. According to Money-Rates.com, the average return on savings accounts under 10,000 as of July 24 was 0.80 percent. Plus, there’s a good chance credit card companies will raise rates significantly when the economy improves. The present environment could be the best time to make meaningful headway with credit card debt reduction.

The debt reduction trend

The flagging economic recovery in the U.S. apparently has consumers following that advice. Financial-Planning.com reports that middle class savings tumbled to an eight-month low in June, according to a report by First Command Financial Behaviors. It was the lowest rate of savings since October 2009. At the same time Americans have stepped up reducing their debt. But the debt consumers paid off wasn’t enough to offset the savings reduction. Those with a positive savings-to-debt ratio, which is total savings compared to total debt, dropped 39 percent in June, down five points from a record-high of 44 percent in the first quarter.

Emergency fund can’t be ignored

Although the numbers dictate that debt reduction may offer more financial benefits that debt reduction right now, Peak said that people still can’t ignore their emergency fund. Everyone should have a monthly savings goal. How much of that cash goes either to debt reduction or savings depends on a person’s situation. If job security is an issue, the emergency fund should get priority. People who feel secure in their jobs could do better by aggressively pursuing credit card debt reduction.

Consumers are paying down their credit card debt and avoiding new charges, so always open your mail and read the fine print from credit card companies busy creating new ways to gouge their customers. Flickr photo.

Consumer credit dropped in May much further than was forecast, with the decline led by significant drop in credit card debt. Credit card delinquencies fell to their lowest rate since 2002. As Americans save more and borrow less, desperate credit card companies are coming up with new ways to gouge customers. New credit card rules aimed at curbing the usurious behavior of credit card companies may be giving consumers a false sense of security.

Consumer credit drop exceeds forecast

A Federal Reserve report released Thursday showed that consumer credit dropped at an adjusted annual rate of 4.5 percent in May–the fourth consecutive month of declining credit.  Revolving debt, which includes most credit card debt, dropped by 10.5 percent ($7.3 billion) in May, according to the Fed’s report. Non-revolving debt, including car loans, fell by $1.8 billion in May. Business Week reports that economists’ projections in a Bloomberg survey ranged from a decrease of $5.2 billion to an increase of $2 billion in May. Consumer credit has increased only twice since the end of 2008. Consumer spending, which accounts for about 70 percent of the economy and is what America is counting on to revive the economy, will be weak as Americans pay down their debt.

Credit card delinquencies also drop

Credit card delinquencies are declining right along with consumer credit. The American Bankers Association (ABA) reported that late payments for bank credit cards fell in the first quarter to the lowest level in eight years. Market Watch reports that bank card delinquencies–card payments at least 30 days overdue, fell to 3.88 percent of all credit card accounts in the first quarter, compared with 4.39 percent in the fourth quarter of 2009. The credit card delinquency rate, the lowest its been since the first quarter of 2002. The ABA reported also said that overall consumer loan delinquencies declined, but only job creation will bring further improvement.

New credit card rules are to be broken

Credit card companies are seeing revenues decline. But even with new credit card rules designed to protect consumers going into effect next month, credit card companies are trying harder than ever to burn customers with creative new fees. CNNMoney.com reports that banks will be able to get around many of the new rules. For example, new rules cap late fees at $25 and do away with inactivity fees, but now more credit card companies are charging annual fees.

Credit card companies hope you won’t notice

When it comes to the new credit card rules, consumers may think that credit card companies can’t raise interest rates on existing cards anymore. But in reality, they can do anything they want with new balances, as long as they give 45 days notice. If your credit card company sent you a letter that you didn’t open a while back and you see your interest rate skyrocket on your latest charges, that’s what happened. Plus, credit card companies can still cut credit limits and close credit cards without advance notice, which will really hurt a credit score.

Always open credit card company mail

Other credit card companies have recently hiked balance transfer fees, cash advance fees and foreign transaction fees. Gerri Detweiler, personal finance advisor at Credit.com, told CNN that read the mail you get from your credit card company is more important now than ever. Don’t automatically assume its junk mail, because you’re only going to have the 45 days to opt out if you actually read the fine print. And as credit card companies become more desperate, they will not only raise existing fees but create all kinds of new fees.

Consumers are cutting up their credit cards, as they're relying more on personal loans. Image from Wikimedia Commons

During economic recessions, you expect people to tighten their belts and cut down on their use of credit, of any form.  It is certainly true that some tightening has happened, but it isn’t as much as you’d think.  It is instead the case that some forms of consumer credit are being used more, while others are being used less.  Credit cards are being paid off, and fewer utilized, but personal loans are being utilized more.  One of the best forms of debt relief is to pay debts, and it seems that consensus is to pay off the cards and be on manageable plans for everything else.

Personal loans on the rise

For the second time in the last 14 months, there was an increase in certain amounts of consumer debt in the United States.  The credit products that were on the up and up were non-revolving sources of credit, such as student loans and personal loans, according to MarketWatch.  The amount of non-revolving credit, such as personal loans, went up $9.4 billion for April.

Credit cards fall

However, one of the most common sources of consumer credit is beginning to slip.  Credit card debt fell more than $8 billion in April, and the overall amount of credit card debt held nationally has not gone up since it peaked in June of 2008.  Non-revolving credit sources, however, have posted gains twice since then.  The result was an overall gain in consumer debt of slightly less than $1 billion overall, a gain of half of one percent.

Increase in other debts

The debt held by the government rose less than $2 billion, and the bulk of those loans are student loans.  The appearance of this economic data would be that consumers are becoming skittish about revolving sources of credit, and would rather stick to installment loan payments over time.  This is not unreasonable, as making the minimum payments on some credit cards can take years to pay off.

The Federal Reserve reported that an unexpected consumer borrowing increase in March is another sign that an economic recovery is underway. Flickr photo.

Consumer credit increased in March 2010, the Federal Reserve reported Friday. The $1.95 billion increase in consumer borrowing surprised economists, who had expected consumer debt to continue a decline that resumed in February after a January spike in money loans. The unexpected March consumer credit statistics mark only the second time the Fed has reported a consumer confidence increase in 14 months. Some believe that consumer spending, making up 70 percent of the economy, is trending to a level that could help strengthen economic recovery.

Consumer confidence on the upswing

News of the March consumer credit increase comes hot on the heels of a Friday Labor Department jobs report announcing that 290,000 jobs were created in April. The jobs increase was accompanied by an increase is the unemployment rate. However, the report said the improved economic outlook is motivating people who had quit looking for jobs during the recession to resume looking for work.

Consumer debt figures a surprise

The increase in consumer credit statistics surprised many economists. Bloomberg reports that a survey of 33 economists had forecast consumer debt in March would drop further from an $11.5 billion decrease reported in February. Projections ranged from a consumer debt decrease of $8.5 billion to an increase of $8 billion. Economists surveyed by MarketWatch expected consumer credit to decline by $4.5 billion in March. The March gain represents a 1 percent rise at an annual rate following a 3 percent drop in February and a 3.2 percent January increase.

Federal Reserve consumer credit statistics

Federal Reserve Consumer credit statistics show that non-revolving debt, including loans for cars and mobile homes, rose by $5.1 billion in March. Bloomberg reports that auto sales in the U.S. rose to the equivalent of 11.8 million annually in March — the strongest performance since August 2009, according to industry statistics. The pace had slowed to 11.21 million in February. Auto sales in March were boosted by Toyota incentives the company offered to make up for record recalls. Ford led U.S. automakers with a 40 percent sales increase. Sales at General Motors increased 21 percent.

Federal Reserve Consumer credit statistics for revolving debt, such as credit cards, fell by $3.2 billion in March. The central bank’s report doesn’t cover borrowing secured by real estate.

Consumer borrowing will fuel recovery

The low rate of personal savings in the United States has aroused a sense of alarm for years. But the Associated Press reports that in the wake of the great recession, economists now say that consumer debt needs to stabilize and grow to prevent derailing the modest recovery under way, although they expect that the rebound will be restrained by tighter credit conditions imposed by many banks.

Capping payday loan rates too low will kill competition and hurt consumers – in Brisbane, Queensland or anywhere else.

Legislators from various nations have proposed that control over consumer credit become centralized, i.e. placed under control of the national government rather than continue to reside with states and principalities. Their reasoning is that if they can provide the traditional banking sector with enough incentive to offer small loans like payday loans at competitive rates, the venture would be profitable and consumers would be protected from predatory lending schemes.

Australia appears to think this is a good idea, as upcoming legislation will enact such payday lending control. Lecturer Nicola Howell of the Queensland University of Technology theorizes in her 2009 paper “National Consumer Credit Laws, Financial Exclusion and Interest Rate Caps: the Case for Diversity Within a Centralised Framework” that centralized credit regulation could be a good thing, but doesn’t fail to notice the potential for major problems that throttle consumer choice when it comes to small loan access.

What Will Happen in Australia, Exactly?

Australia will transfer consumer credit control from State and Territory Governments over to the Commonwealth. The goal is for a uniform system to regulate consumer credit and form a “seamless national regime.” The assumption is that the change in regulatory power will result in greater responsiveness to the dynamic market, which was greatly desired after experience with the “slow pace of change in the current State and Territory-based regime.”

But Financial Exclusion is Not Addressed

Some in Australia welcome this change, but Howell argues that the change will not sufficiently address the issue of financial exclusion. Howell defines financial exclusion as “the lack of access by certain consumers to appropriate low cost, fair and safe financial products and services from mainstream providers.” This means small loans and payday loans. Centralized consumer credit regulation, Howell fears, could create interest rates that make it impossible for many payday lenders to operate. This in turn would limit consumer credit options. “There is an absence of any consideration of regulatory initiatives that might encourage the availability of low cost, fair and safe small loan products,” writes Howell.

But Howell Feels a Cap is Necessary

Ample evidence exists that using rate caps as a regulatory tool affects consumers negatively. Here’s one of many examples. Howell admits that “total centralization of consumer regulation does pose some risks for consumers, by way of potentially reduced standards, and reduced opportunities for regulatory experimentation and local responsiveness,” so the potential for danger is recognized. Perhaps that’s why “permitting regulatory diversity on interest rate caps” in case consensus cannot be reached on where to set the rate cap bar is on the author’s mind.

No to Financial Exclusion of Essential Products

The authors states (and is definitely not alone in this regard) that the products consumer credit markets offer for cash emergencies – such as payday loans and other small loans – are as essential to well being as utility services like electricity and water. Thus, efforts should be taken to maintain their availability to the public. Keep payday loans available and affordable; don’t cap them to the point that payday lending businesses have to close their doors, costing communities jobs as well as options for credit.

Promoting Competition?

If designed properly, a rate cap could indeed regulate prices without squelching choice. But the kind of APRs most legislators talk about (whether it is Australia or America) can typically only be swallowed by large institutions, i.e. traditional banks. Thirty to 40 percent APRs work for companies already rich with capital, but not for smaller payday lenders. Consumers go to such lenders because they can’t crack the surface with traditional lenders like banks, frequently because of credit issues. If their main credit option for emergencies and smoothing consumption shocks is taken away, what are consumers left with? That would be loan sharks and similar dangerous options.

In their efforts to stay alive when faced with shortsighted regulation, some payday lending companies have found ways to circumvent unfair rate caps. Since payday loan companies are not raking in excessive profits to begin with and it’s been proven that small loans can’t work under restrictive rate caps, Australia should take notice. Unless they don’t mind hurting their citizens, that is.

Learn from America’s CRA Disaster, Australia

Howell compares Australia’s Commonwealth coaxing banks to enter the payday loan market to what the Community Reinvestment Act (CRA) did for the housing market in the United States. While the CRA was designed to “encourage depository institutions to meet the credit needs of their communities, including the needs of lower-income consumers and neighborhoods,” writes Howell, the reality is that their strong-arming efforts helped produce the subprime mortgage mess that nearly destroyed America’s economy. Along with ACORN, the Community Reinvestment Act (CRA) sought to curb redlining, but what they achieved is that they convinced lenders to relax their lending standards so much that they began lending and granting mortgages to people who couldn’t possible repay. As the Wall Street Journal put it, ACORN and the CRA “laid the foundation for the house of cards built out of subprime loans.”

Will the Commonwealth Sweat Banks Under the Hot Lights?

The CRA “required banks to increase lending in low-income neighborhoods.” Enforcement terms were vague, but in practice it meant that ACORN and the CRA could pressure banks into subprime lending because doing so somehow fought against racism. American lenders that didn’t comply were threatened with me branch expansion, mergers and acquisitions being blocked. ACORN and the CRA could effectively shut a bank down if they didn’t comply. Is that what Australia really wants to do to its banking system and its consumer base? I’m surprised Howell missed this notorious piece of American financial history, being a professional researcher.

Empowering the Consumer

Here’s a more reasonable line of thought that Howell touches upon: “Rather than imposing price regulation,” she writes, “competition between lenders should be encouraged, and consumers should be empowered to choose the most appropriate products for their needs.” Yes, on this we can agree, as well as on the fact that “centralization and uniformity in law is not necessarily always beneficial” for said consumers. Who is to say that uniformity would automatically lead to the greatest standards? Europe can weigh in on this, as Bourgoignie and Trubek state in their 1986 study “Consumer Law, Common Markets and Federalism in Europe and the United States” that

Once again, it must be stressed that uniformity does not necessarily advance consumer interests… There is a possibility that uniformity will be used to cut back consumer rights.

Cut back consumer rights? Is this necessary for Australia? Is it necessary anywhere? Consumers aren’t forced to use payday loans, but they do because of a speed and convenience that traditional banks and credit unions can’t match.

“There Are Potential Risks,” Says Howell

“In the context of interest rate caps,” she writes, “these risks, together with the fact that it is likely to difficult to find a consensus approach, or to conduct a comprehensive analysis of the relative merits of the different approaches within the reform timeframe, suggest that there may be some merit in permitting diversity on interest rate caps to remain, at least for an interim period.” This, Howell postulates, could help minimize financial exclusion. Since the Australian Commonwealth’s current proposal doesn’t address this potential harm to consumers, it is advisable that rash action not be taken to cap interest rates too low. This is where Howell’s diversity comes into play around the APR cap. Australian consumers who are more vulnerable to financial shocks should have the option to use payday loans if the traditional banking system fails them.

President Obama's plans for the Consumer Financial Protection Agency could mean that debt relief is closer than ever for the downtrodden. (Photo: flickr.com)

The recession has forced America to face some of its most deep-seated systematic financial troubles. One thing that has become clear is that unscrupulous mortgage lenders and credit card agencies have dined for far too long upon consumers who largely didn’t understand that they could hold out for something better. Foreclosure and bankruptcy have amplified the burden on consumers, courts and the economy as a whole tenfold, which makes the question of how debt relief should be handled a more pressing issue that it has been in decades.

Cornell and George Washington Law School Economics lecturer and former professor Dr. Neil Buchanan ponders in a recent FindLaw column entitled “Should Federal Agencies or Courts Protect Consumers in Financial Markets?” which side of the regulatory coin America needs most. Existing regulatory agencies are being given more extensive duties by the Obama administration in order to help make America’s financial markets safe and sound. At the same time, new agencies like the newly minted Consumer Financial Protection Agency appears to be on its way to receiving unprecedented powers. In theory, it will have the power to police how mortgage lenders, banks, credit card companies, payday lenders or any other consumer finance company interacts with consumers. It is Buchanan’s opinion that allowing regulatory agencies to protect consumers is the best route, as relying solely upon the courts wouldn’t be enough of a deterrent to keep suspect lenders from indulging in bad behavior. The ideal system would have both in place as a regulatory enforcement clearing house.

But Isn’t This Big Government Clogging the Market?

Some will surely feel that way. What I have seen from state governments is an overzealousness to regulate payday lending, to the point where it is impossible for such legitimate businesses to operate in some states. Mortgage lenders and credit card company supporters would likely have similar complaints, although the path of destruction their industries have carved is rather hard to ignore. Buchanan begins his argument by considering the “courts only” option. If it were possible t regulating a market in need of deep repair like the mortgage industry through simple enforcement of the law, that would be ideal. However, Buchanan doesn’t see that as being enough. Sometimes the courts might work in favor of the consumer and debt relief, but not often enough. Extreme circumstances would be required to convince most judges to see cause to invalidate a contract. The “non-elite” consumers, as Buchanan calls those most in need of debt relief, would not receive the help they need.

There is precedent here, but it could be a one in a million kind of thing. Buchanan points to a New York Times story where a judge ruled that a homeowner’s mortgage debt could be completely discharged during bankruptcy. This loop in legal convention happened due to a technicality: the mortgage company couldn’t prove it had the legal right to collect payments on the homeowner’s mortgage due to the fact that their mortgage had been repackaged and resold so many times that the paper trail had been lost. The mortgage company claimed this was “standard procedure” now, but the judge wouldn’t accept such shenanigans. Since the judge wasn’t exactly sure who was due the money, he decided he couldn’t compel the consumer to make mortgage payments to any one party.

“Saved by a Technicality” Won’t Work for Everyone

Buchanan rightly points out that not all judges will be as determined to call mortgage lenders’ bluff in such situations. “Standard procedure” should hold in most cases, meaning that homeowners would still be legally obligated to follow the terms of their mortgage contract. And mortgage lenders have certainly learned something from that case and are making sure all paperwork is in order. Once again, the deck will be stacked against consumers.

Don’t Depend Upon Courts for Debt Relief

Courts enforce the law. When a consumer enters into any legal contract with a lender, the terms of that contract are in most case subject to enforcement by law. Buchanan considers the vast majority of consumers to be “grossly mismatched” against mortgage and credit card companies. Mandatory arbitration clauses, hidden interest spike triggers and means of computing interest are always written in the best interests of the creditor. Consumers often agree to such contracts because they feel they don’t have any other choice. New regulatory agencies may be able to curtail abusive practices that are currently considered legal, but until that time officially arrives, there is too little hope that the average consumer will be able to fight back through the court system.

Courts Have Been Friendlier to Finance Companies

Families can go to court to attempt to prove that they shouldn’t have to pay under the terms of less than legal contract. However, Buchanan believes most judges will stick to enforcing contract language. In turn, the lending companies themselves are effectively using the court system to compel consumers to pay, even if it is through wage garnishment.

What about “Equitable Doctrines” for Debt Relief?

Hoping that lenders lose their paperwork isn’t a good strategy. That’s where “equitable doctrines” come into play. These can create situations where courts might be willing to set aside otherwise valid contracts because they feel that it there were unconscionable circumstances that placed the consumer under duress or undue influence to sign. Buchanan draws our attention to the “doctrine of unconscionability” itself, claiming that it works in two ways. First, in terms of procedure, there is the scenario where a contract was formed under suspicious circumstances. Second, there is the scenario where the substance of a contract is deemed grossly unfair. If both conditions are met, a contract like a mortgage, credit card agreement, etc, will not be enforced.

Too Good to Be True?

Perhaps it is. It all looks great on paper, says Buchanan, but debt relief is hard to come by via equitable doctrines. Only the most extreme cases are considered by courts, and for most people, having trouble paying a mortgage or credit card they signed up for won’t be enough to sway a judge. This raises the question in Buchanan’s mind as to whether courts should be compelled by stronger legislation to accept equitable doctrine arguments based on things like unconscionability. But as with any other action fought through courts, the cost would likely be prohibitive. Moreover, lenders would still be favored because “losing a contracts case legally cannot result in a company paying punitive damages,” writes Buchanan. “If you lose a contracts case, you merely pay what you would have paid anyway; and if you win, you are ahead. Thus, from the standpoint of repeat players, there is no reason not to abuse your customers (except to maintain goodwill, which many of the companies at issue here have already forfeited).” Then there are plenty of consumers who simply will not have the stomach to sue or be willing to accept a lesser settlement.

Calling on the Government for Debt Relief

Traditionally, the government has remained behind the scenes while consumers have pursued their right to take debt relief matters before the court system. As Buchanan suggests, however, this route has not often proved itself to be effective for the average consumer. In situations where genuine signs of abusive practices and unconscionable contracts are involved, new government agencies could take up the baton and make financial regulation more consumer-friendly.

“An agency can be empowered by Congress to order changes in behavior, changing business practices broadly and generally in order to level the playing field on which financial institutions and their customers do business,” says Buchanan. There could even be scenarios where lenders themselves could support agency regulation over the courts. “Out of control lawsuits” that financial institutions claim burden them unnecessarily would certainly be something lenders would be willing to leave behind so that a regulating agency can rule on matters. “But that hypothetical,” Buchanan writes, “ignores the financial industry’s real agenda, which is to fight to maintain both weak legal rules (allowing them to win in court) and weak-to-nonexistent agency regulation.”

Congress, Act Now

New agencies are about to spring forth from the executive branch to regulate the financial abuse of consumers through deceptive practices. Congress is in a perfect position to arm these agencies with more consumer-friendly laws that will make reasonable debt relief easier to attain. It’s that kind of consumer protection that Neil Buchanan and most concerned consumers are in search of as America looks to emerge from the darkness of the recession into the light of a stronger domestic America.

Consumerism is American. Free market capitalism and payday loans are all part of necessary competition, despite what critics would have you believe. (Photo: flickr.com)

If media and banking industry critics of payday lending are to be believed, payday loan outlets are perched in the reeds, muscles coiled in anticipation of springing upon unsuspecting consumers. “Predatory lending” is the fallback term such misinformed critics use, under the assumption that people who use payday loans are tricked or somehow lured into doing so. Yet ample evidence exists that indicates that payday loan customers are educated and take time to consider their options before choosing the short term loan product.

Understand Who Uses Payday Loans

Edward Lawrence and Gregory Elliehausen studied who uses payday loans and why in their April 2008 Contemporary Economic Policy article “A Comparative Analysis of Payday Loan Customers.” Using a national survey that takes into account numerous payday loan outlets belonging to industry trade association the Community Financial Services Association (CFSA), the authors reach beyond the veil of anecdotal evidence as they interview 427 payday loan customers from the survey. Rather than finding an uneducated, unsophisticated group that is being victimized against their will or better judgment, Lawrence and Elliehausen found that payday loan customers consider their decisions carefully and weigh the cost of payday loans against other costs both monetary and environmental.

Consumers, Consumption and Debt Burden

Consumer credit fills a definite need, particularly for segments of society without a great deal of liquid assets at their easy disposal and a significant debt burden. Building upon Juster and Shay’s 1964 study “Consumer Sensitivity to Finance Rates: An Empirical and Analytical Investigation,” where consumer credit is seen to be used on household durable goods, and multiple studies that suggest that such a method is financially feasible when the rate of return is high, Lawrence and Elliehausen point toward a model where high interest payday lending may be optimal for certain consumers. The conditions under which the authors see this would be the case are “relatively high-return investment opportunities, low current income and strong preferences for current consumption.”

Yes, We Live in a Consumer Culture

Americans see it as their right (and their curse) to “keep up with the Joneses.” When this behavior is left unchecked, personal debt can spiral out of control. Thus, when consumers look to short term loans like payday loans to handle financial shocks, they do so in large part because they do not have the liquid assets available to handle their debt obligations in lump sums. Creditors know this, so they tend to limit the amount of credit they extend so as to protect themselves from default. Unsecured personal loans are available from payday lenders to make up the difference. They are available at a cost that the authors find consumers are more willing to swallow than more expensive or socially taboo alternatives.

The Rise of Rationed Borrowers

The authors refer to the Juster and Shay study in stating that borrowers constrained by their debt loads are “rationed” borrowers. Juster and Shay theorize that rationed borrowers are “in early family life-cycle stages where rates of return on household investments would be high.” Their income would be low to moderate, which would explain the small amount of liquid assets available. Furthermore, their demand for consumer credit would be connected less to interest rates and more to the general lack of standard credit available.

That’s the way Juster and Shay saw it in 1964, 45 years ago. Things have changed a great deal since then. Creditors have a greater technical facility for assessing and pricing risk, say Lawrence and Elliehausen. The requirements for equity have lessened and the time for short term loans to reach maturity have lengthened. Unsecured credit through bank-issued credit cards has also become more readily available. There is a “subprime credit card market” for today’s rationed borrowers, but there are other alternatives that do not deal so heavily in the constant spiral of revolving debt. Payday loans have been a prime alternative for rationed borrowers.

NOT Preying Upon the Elderly

Some critics of payday loans claim the industry preys upon the elderly. However, numerous recent studies indicate that young and middle-aged consumers have contributed to an increasing demand for short term loans. Their drives are somewhat different, as Lawrence and Elliehausen’s findings show. For the young, their demand for payday loans has been predicated on how quickly they can pay off their short term loans (seven to 20 days is standard) and hence regiment their budget, whereas middle-aged  consumers’ demand is more in tune with obtaining better interest rates.

Budgetary Discipline

This sense of maintaining a budget in the face of environmental pressures resonates through various other studies. Katona’s “Psychological Economics” (1975) indicates that consumers “may be reluctant to increase credit card debt because they fear that they will not have the discipline to make payments on the additional debt.”In this case, Lawrence and Elliehausen hypothesize that consumer use of payday loans via a standard contract may be expensive in a traditional sense, but if the alternative is increased vulnerability to higher debt or even an inability to access credit, the short term loans are preferable in the long run.

Survey Says

Payday loan customers surveyed by Lawrence and Elliehausen tend to break many of the stereotypical notions spread by critics of the industry. They are not in fact poor; just over half had family incomes between $25,000 and $49,999. Considering that having an active checking account is a requirement for obtaining a payday loan, unbanked households (generally lower income) are not being exploited by such short term loans. In terms of age, two-thirds were under 45 years old, with more than one-third under 35. Only 10 percent were 55 or older, so clearly the elderly is not being targeted. Family situations indicated more than half were married or living with a partner, and 65 percent of respondents had children under 18 years of age living in the household. These are young families with debt loads who are attempting to deal with financial shocks as best they can. Now that America is in a recession, I’m sure that if Lawrence and Elliehausen conducted their survey today, the numbers would continue to support this idea.

Do They Have Other Options?

The survey indicated that a whopping 91.6 percent of payday loan customers do rely on other types of consumer credit at times. However, considering the finding that payday loan customers are less likely to use revolving credit like credit cards, one would think that they find an advantage in using the more regimented payday loan model. I would offer that it is precisely that budgetary discipline discussed earlier that makes payday loans more appealing for these rationed borrowers.

Of course, having other credit options tends to go hand-in-hand with the potential for a greater debt burden. As such, the authors’ survey found that 73 percent of payday loan customers had been turned down or limited in their ability to secure other types of loans over the past five years. Payday loans become a necessity during financial emergencies if other options are limited. In fact, two-thirds of respondents claimed they used payday loans due to unforeseen financial events.

Making Informed Decisions

Lawrence and Elliehausen found that respondents to the payday loan survey tended to follow cognitive models suggested in other consumer credit studies. Specifically, they go through a process where they recognize need, gather details, consider options, decide and then evaluate how it went in the aftermath. As the majority of consumers in the survey appeared educated (the majority were high school graduates or had college experience), it would stand to reason that payday loan customers tend to display cognitive ability and efficiency. In the case of details like APRs and finance charges, greater education tended to equate to greater awareness (where such factors were considered important in the decision-making process).

Young Families Who Consider Options Carefully

Lawrence and Elliehausen’s findings speak to the financial realities facing many American families. They’re just starting out, their wages are not yet high and they don’t have many liquid assets lying around for a rainy day. Used in a non-habitual fashion, payday loans help absorb financial shocks during times of financial difficulty. They give consumers “a little control over their financial affairs they otherwise would not have,” write the authors. Is it any wonder then that customer attitudes toward payday lending were positive in the survey? There is peace of mind in being able to handle one’s own affairs. Since the majority of those surveyed did not show signs that they were using payday loans beyond the fashion for which they were intended, why is it that the government should be so gung-ho to step in with heavy regulation and taxation? By stymieing competition in a free market economy and restricting payday loan availability, aren’t they harming both consumers in need and their own capitalist system?