Consumer advocates have long warned that payday lenders purposely try to lure borrowers into an expensive and debilitating cycle of debt. Now, the nation's consumer financial watchdog says it has proof.
The allegations against Ace marked the first time that bureau officials accused a payday lender of intentionally pushing people into a debt cycle.
Ace, with 1,500 storefront locations in California and 35 other states, agreed to pay $10 million to settle the case, without admitting or denying wrongdoing.
The Irving, Texas, company issued a statement noting that it cooperated with the bureau's investigation for two years and that nearly all its employees' calls to customers complied with collection rules.
The bureau's investigation turned up a graphic from an Ace training manual showing the circular loan process — how customers were being contacted to take out new loans after failing to pay off old ones.
"Ace used false threats, intimidation and harassing calls to bully payday borrowers into a cycle of debt," bureau Director
The bureau, created by the 2010 financial reform law, has tried to crack down on payday lending abuses and is considering whether new federal rules are needed.
Payday loans, long a fixture of working-class and low-income neighborhoods, became more popular during the Great Recession and its aftermath as cash-strapped consumers looked for a quick fix to tide them over until their next paycheck.
About 20,600 payday locations across the country make $38.5 billion in such loans each year, according to the
The short-term loans, typically $350, are cash advances on a paycheck. The loans typically are for two weeks with a flat 15% fee or an interest rate that doesn't sound too bad.
But costs can multiply quickly if the loan is not paid off and the borrower needs to take out another loan to pay off the first one.
The Ace case provides stark evidence of the industry's business model and could lead to tougher regulations from the consumer bureau, said Nick Bourke, director of the Small Dollar Loans Project at the Pew Charitable Trusts.
"A payday loan is marketed as a short-term temporary fix," Bourke said. "But the reality is most people need half the year to pay the loan back."
Customers can end up spending more in fees than the amount of the original loan, he said.
"The payday loan business model would fall apart if customers only used it for two or three weeks at a time," Bourke said.
The Ace training manual graphic provided "an explicit picture of the debt trap," said Mike Calhoun, president of the Center for Responsible Lending.
"It's real. It's abusive, and it's time to stop," Calhoun said.
In March, the consumer bureau said its analysis of the industry found 4 out of 5 people who took out a payday loan either rolled it over into a new loan or took out another one within two weeks.
The allegations against Ace came after an investigation triggered by a routine examination of the company's operations as part of the bureau's oversight.
The bureau said its investigation found that Ace's in-house and third-party debt collectors used illegal tactics, such as harassing phone calls and false threats to report borrowers to credit reporting companies, to try to force them to take out new loans to pay off the old ones.
"Ace was relentlessly overzealous in its pursuit of overdue customers," Cordray said.
In a statement, Ace said it hired an outside expert who found 96% of the company's calls to customers "met relevant collection standards." The company also questioned the notion that it lured customers into a cycle of debt.
The company said an analysis of its data from March 2011 through February 2012 found 99.5% of customers with loans in collection for more than 90 days did not take out new loans with Ace within two days of paying off their existing ones. And 99.1% of customers did not take out a new loan within 14 days of paying off existing loans, it said.
Still, Ace said, it has taken steps since 2011 to prevent abuses, including increasing its monitoring of collection calls and ending the use of an unnamed third-party collection agency that the bureau had concerns about.
As part of the settlement, Ace will hire a firm to contact eligible customers and issue refunds, the bureau said.
Consumer advocates hope the bureau will write federal rules requiring payday lenders to determine a customer's ability to repay before issuing loans.
"Certainly there's a time in everyone's life when they may need a small dollar loan," said Pamela Banks, senior policy counsel for Consumers Union. "But we advise consumers to think long and hard about whether they need the loan."
If they do need money, they should first turn to family, friends or even their church — "anything short of a payday lender," she said.