Predatory lending is characterized by a variety of practices that often trap borrowers in a cycle of debt. Predatory practices include the following:
- Triple digit annual percentage rates on short-term loans. While the Alabama Small Loan Act caps APRs at 36% on small loans, the payday loan industry has successfully lobbied the Legislature to be considered not a provider of “loans” but rather a “deferred presentment” services provider. This ensures that it is not subject to the Alabama Small Loan Act. The Deferred Presentment Services Act caps transactions at 17.5%, but this interest rate typically annualizes to over 400% APR.
- Extremely short loan terms. Payday loans are typically two-week loans. An individual who is experiencing a financial crisis and turns to a payday loan as a solution may be just as financially insecure in such a short turn-around time, thus limiting his or her ability to repay the loan on time.
- Single “balloon” payments. The borrower typically must pay back the entire amount of the loan in a single, large payment, rather than in periodic installments.
- Loan flipping. Loan “flipping,” is the practice of providing a new loan to a borrower immediately at the time of repayment of the first if the borrower is unable to pay off the first loan. Many payday lenders continue to roll over small loans every couple of weeks, often creating a situation where a borrower pays significantly more in interest than the original loan amount.
- Lack of consideration of a borrower’s ability to repay the loan. Most loan providers consider a borrower’s financial situation and the likelihood that he or she will have the ability to repay a loan before extending the loan. Many lenders in the subprime, predatory market often extend an immediate approval to borrowers without an evaluation of whether they will have the future ability to repay the loan.
- Charging a higher interest rate than what a borrower might qualify for. Many borrowers may be unaware that they are eligible for a prime rate loan, and predatory lenders typically will not inform borrowers of this fact but simply charge a higher, subprime rate.
Payday loans are often marketed as a temporary solution for an individual to get extra cash for an emergency, but empirical data shows that they are seldom used simply in this way. Over 90% of payday loans are made to borrowers who take out over five payday loans per year. Loans to non-repeat borrowers account for just 2% of the payday loan volume.