Will that be cash, check or debtor's hell?

The statistics are clear. The market has spoken, and it likes check cashing services and payday, title and pawn loans—or at least a significant portion of the market does. The rest of the consumer market looks at their comparatively high costs, scratches its collective head and wonders, "Why?"

The reasons why people use fringe banking services are a complex web of financial desperation, product convenience, target marketing and a healthy dash of consumer naivete.

For starters, most customers "have severely impaired credit" and have little or no savings to fall back on, according to John Caskey, a professor at Swarthmore College. Despite the fact that most hold full-time jobs, such households have trouble weathering small financial crises, and past financial mismanagement means their sources of credit might also be limited.

Banks, for example, don't typically make the $200 loans common among payday lenders. Given poor credit histories, credit cards can also be difficult to obtain (and, in fact, can be the original source of financial problems). Caskey's research has found that about half of all customers of fringe bank outlets have credit cards. Third-party research of a large title loan company with offices in the Ninth District found that less than one-quarter of the company's customers had credit cards, and just one in 10 had a general use bank credit card (rather than a gas or retail credit card).

Getting a payday loan also requires little more than an open checking account, driver's license, proof of a job and a phone bill to confirm residency. Stores are often open longer hours than banks; some check cashing outlets are open 24 hours a day. Although banks offer increased convenience—ATM, phone and Internet transactions—such a model is also decreasing the industry's reliance on labor. In contrast, the high-volume, low-value (per transaction) market of nonbank financial services has created a labor-intensive, face-to-face model that puts a premium on friendly customer service, several sources said.

Despite their high costs, filling a financial shortfall with a payday or title loan can also be cheaper in the short-term than bouncing checks. A single bad check, regardless of value, typically runs at least $30 after adding in both bank and merchant fees, and can go as high as $50. Multiply that by several checks without proper backing and payday and title loans can be much cheaper if paid off on time and assuming the cash shortage is unavoidable.

Bank fees are also increasing. In a recent report to Congress, the Federal Reserve found that in 1999 "the level of fees at banks increased significantly" in nine of 21 cost categories, and went down in just two over the previous year. It found that the number of banks offering free, noninterest-bearing checking accounts dropped from 18 percent to 11 percent, while bank fees for stop-payment orders, nonsufficient fund checks, check overdrafts and returned deposits all went up between 4 percent and 6 percent. The rate increase for these three fees went up between 8 percent and 17 percent in Minnesota and between 12 percent to 20 percent in Wisconsin, with per-charge fees in each state ranging between $11 and $18.

Marketing, price sensitivity and delayed gratification

Critics charge that companies make services and products—particularly payday loans—too easy to obtain, and fail to be upfront and truthful about the full cost of these transactions in their advertising and marketing.

"You won't find a yellow page ad that says 'We have 400 percent APR, come on down,'" said Jean Ann Fox of the Consumer Federation of America. "These are advertised and marketed as one-time, cash-flow management [loans], when in fact these turn out to be the first step of a slippery slope" of personal debt.

In some cases, customers might not fully understand—or care to understand—the long-term or comparative costs of these products, according to Gary Preszler, North Dakota banking commissioner. "They want to know what the payment is. They don't care about the rate or what the ultimate cost of the loan is," Preszler said. "They don't weigh the consequences."

But given a customer base in the millions, even consumer advocates admit that not all customers are being duped or tricked into these transactions. As such, price insensitivity appears to play a big role in people's decision-making. A report on the payday industry by an investment banking firm said customers primarily use the service "due to their unwillingness and/or inability to delay consumption. ... Consumers are often convenience driven, not price driven, when it comes down to choosing between immediate consumption vs. delaying consumption."

To many, consumer education on financial matters is often lacking and compounded by a society fixated on immediate gratification. "Today, it's instant. You want it and you have to have it now," said Jim Rhodes, education director of Metropolitan Financial Services/Auriton Solutions, a nonprofit that counsels "people who've hit [financial] rough spots."

Rhodes called payday loans a "dangerous" product, but acknowledged that credit cards, high-interest auto loans and other subprime credit products play a bigger role in the debt structure of Metropolitan's clientele.

Metropolitan gets 4,000 calls a year, and on the day contacted, had received 173 calls by mid-afternoon. "We can't handle the business," Rhodes said. "If there's a downturn in the economy, you ain't seen nothing yet."

Related articles: fedgazette, July 2004 Banking on the fringe