Cap cash advance, payday loan interest rates, group says

Maybe you've driven by a cash advance or payday loan franchise in your area and wondered about the people you saw coming and going. These storefront shops are a source of quick money for the cash-strapped -- people with bad credit or no credit and as a result are not likely to have access to bank or credit union loans or credit cards.

Quick cash
The typical customer is working but doesn't earn living wages -- enough to support themselves and their families. Because they work, they qualify for payday loans, a lending scheme that has grown into a $28 billion a year industry. Patrons need only have a pay stub to verify employment and a checking account. They can then borrow small amounts (the average loan is $300) and sign a personal check made out to the lender and dated on their next pay day. 

If the Center for Responsible Lending had its way, those payday shops would probably have to hang "Customer Beware" signs out front to keep consumers away. The North Carolina-based, non-profit just published "Financial Quicksand," a report worth reading if you've ever considered taking out a payday loan or know someone who has.

400 percent interest
Basically, the group found that these loans end up costing the typical customer 400 percent in fees and interest. (Yes, 400 percent. That's not a typo.) A person taking out a $325 loan may pay back $793.

How is this possible? The loans must be repaid in full in two weeks (by the next pay day) and in that short period of time many people have not resolved the financial crisis that sent them scurrying for quick cash in the first place. That means they end up renewing the loan (called flipping) and racking up more fees with each renewal.  Borrowers become trapped in a debt spiral.

"The process of loan flipping creates the long-term cycle we call the debt trap," the report says.

An Ohio homeowner in foreclosure counseling told CNNMoney.com:

"You get a payday loan and you take your pay next payday and pay back the loan. Then you don't have enough money to last to the next payday, so you go back. If you don't pay the loan, they call everybody from your employer to your sister."

36 percent cap
The Center for Responsible Lending is calling on all states to adopt laws that cap payday loan fees at 36 percent. The group estimates that payday and cash advance lenders rake in $4.2 billion in excessive fees from borrowers. 

A spokeswoman for the Community Financial Services Association of America, a trade group that represents payday lenders, told the Associated Press that capping interest on the loans would lead to a "complete ban of the payday advance product. Banning a popular, regulated, short-term credit product is not a consumer protection."

Working class 'victims'
Some people have little sympathy for the 'victims' of payday loan traps. (See reader comments on Motley Fool's "The flip side of payday lending") From what I've seen personally, payday loan borrowers are working class, poor people, often new immigrants who may or may not speak English well and are not savvy about personal finance and managing money. They may be ill-equipped to fight or complain about predatory lending practices. They are most in need of strong consumer protection laws.

See related: "4 wrong ways to escape credit card debt"