With Americans earning more and saving less, an expensive short-term loan geared to checking account holders is gaining popularity-to the alarm of consumer advocates and state regulators.

Payday loans, as they are known, let anyone with a job history and a checking account write a personal check against his or her next paycheck for a fee of 10% to 30%. The borrower is expected to pay back the advance during the next pay period-or swallow another 10% to 30% fee.

These loans, the originators say, spare consumers from hefty fees for bounced checks and help them protect their credit records.

But payday lending is drawing criticism from consumer advocates and state regulators, who point to effective annual interest rates near 1,000% and blame the loans for encouraging overspending and driving some borrowers into bankruptcy.

"Consumers who take out these high-cost loans are often forced to renew them or fall behind on other financial obligations, creating a vicious cycle that exacerbates the problem," said Rob Schneider, a lawyer for Consumers Union in Texas. He said thousands of families in the state are being "victimized" by the lenders.

The controversial business, though still small at about $1 billion in originations last year, is on the brink of a boom, observers say. Its sudden prominence signals a shift in the way low- to middle-income consumers handle their finances and underscores their newfound reliance on institutions other than banks to deal with problems.

National chains have replaced the mom-and-pop storefronts that once dominated the payday loan business. A powerful lobbying organization, direct deposits of federal payments, and a nearly nonexistent savings rate among some segments of the U.S. population are driving volume higher.

Meanwhile, Wall Street interest in these companies' high profit margins could boost the business even more, some say.

Market leaders include Check Into Cash of Cleveland, Tenn., which opened in 1993 and by 1998 had 340 outlets in 15 states. In the first six months of 1998 it brought in $21.2 million of revenue, nearly matching its 1997 total of $21.4 million.

In July 1998, Check Into Cash filed with the Securities and Exchange Commission for a $50 million initial public offering, listing CIBC Oppenheimer as underwriter. The company has still not gone public, though, because of a risk-averse market in the second half of last year.

"The Wall Street community is intrigued by the industry," though it is "a little leery," said one equity analyst.

CNG Financial Corp. of Cincinnati, parent company to the Check & Go franchise, is another big player.

Started in the early 1990s by David and Jared Davis, sons of Provident Financial Group's longtime chief executive Allen Davis, the chain has hundreds of stores.

"The industry has experienced phenomenal growth in the past three or four years," said president David Davis. Mr. Davis is an active participant in the industry's new trade group, which is lobbying states to enact legislation legalizing and regulating payday lending.

The U.S. Treasury's decision to directly deposit all federal payments this year has check cashers spooked-and angling to develop payday loan programs to protect profits.

Check cashers are also trying to form bank partnerships in order to become official distribution points for these federal payments and then presumably offer the recipients a debit card, or even a payday loan.

Eagle National Bank in Upper Darby, Pa., has been making payday loans for three years, said president Murray Gorson.

The $50 million-asset bank is in partnership with companies that operate in states where payday lending is illegal, makes the loans for them, then carries the loans on its books.

"It's similar to a credit card advance," Mr. Gorson said. "They give out the money, but we make the loan."

The product is responsible for about one-third of Eagle's income annually, Mr. Gorson said.

Eagle's partners include Dollar Financial Group, which has been buying up small check cashers with names like Almost-A-Banc in Tidewater, Va., and bringing payday lending to states that may not allow the check cashers to make these loans on their own. The practice isn't going unnoticed-Majors & Fox, a San Diego law firm, filed suit in January charging Dollar with racketeering law violations and Eagle with violations of the National Bank Act.

Other banks are eyeing the business, but their participation is limited.

Wells Fargo & Co. offers small payday loans to customers who have their paycheck directly deposited to their checking account.

Citibank, a unit of Citigroup, is working with check cashers to create a debit card product that would let customers without bank accounts gain access to cash through a check casher, said Eric Norrington, vice president of marketing at America's Cash Express in Irving, Tex.

The surge in payday lending has prompted 19 states to set fee limits and disclosure requirements. The industry is actively lobbying states that prohibit the loans and seems to be getting a warm welcome.

Most recently, the Tennessee General Assembly passed a provision lifting the temporary status of payday legislation that had been in place there for two years.

Detractors claim that the industry's successful legislative track record is due in part to strong-arming and payoffs.

"When there's the threat of negative legislation in a state, lenders get all their stores to kick in money and hire a political heavyweight," said Jean Ann Fox, director of consumer protection at the Consumer Federation of America.

Payday lenders and their families gave $105,000 to Tennessee lawmakers from October 1996 to October 1998 and hundreds of thousands of dollars in "soft money" to the Republican and Democratic parties, according to an Associated Press report.

The industry's critics, meanwhile, are working hard to shut it down. "An an awful lot of people live paycheck to paycheck and have no savings," Ms. Fox said.

"In addition, a lot of families are carrying heavy credit card burdens. The explosive mixture leaves consumers with no assets and no resources and no more credit-it makes them desperate," Ms. Fox said. "That's why we have laws-to protect the needy from the greedy."

Texas consumer groups have launched the most recent fight. In late February Consumers Union in Texas called upon the state Attorney General's office and Consumer Credit Commission to end what it calls "legal loan sharking."

At least one of the state's regulatory bodies seems to be on board.

"We view most of these companies as attempts to get around the usury law," said Texas consumer credit Commissioner Leslie Pettijohn. Texas law prohibits lenders from making small loans with annual percentage rates of more than 200%.

"We're in the midst of a number of investigations and are working with the attorney general," Ms. Pettijohn said.

Ms. Pettijohn said she doesn't buy the argument that these lenders are cheaper than bad check fees. "Customers ought not to be writing checks if they don't have the money to cover them," she said.

Finance companies that have long specialized in making small personal loans, meanwhile, are just plain jealous.

"These guys are big competitors of ours ... and they're making a lot of money," said Charlie Walters, chief executive and founder of World Acceptance Corp., a Greenville, S.C., company that has been making small, high-rate personal loans for 30 years. In fact, Mr. Walters said, he has considered entering the business.

But do the high rates that these lenders charge qualify as usury?

Nonbank veterans like Mr. Walters don't think so. "Let me tell you what- if you need $200, and you really need it, and I charge you $30 to get it, that's a service," Mr. Walters said.

"When you go to the convenience store, you pay 30% to 40% more for milk and bread because that's what it is-convenient," Mr. Walters added.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.