Payday Loans: Why you should think twice before getting one?

 

        According to a 2019 survey conducted by Go Banking, 69% of Americans have less than $1,000 in savings, leaving many in a vulnerable situation should an emergency arise; and unfortunately emergencies do arise. Whether it's a broken household appliance, car troubles, an unexpected bill, or an unforeseen medical issue, sooner or later, you will be faced with a situation that requires money that you may not have planned for. So, what happens when someone without savings is hit with an emergency that needs to be paid now? Some may turn to their credit cards, others may be able to borrow money from a friend or family member. But what if these options aren’t available? Enter the Payday Loan. An option that roughly 2.5 million American households turn to according to The Economist, despite the less than unfavorable terms which I will get into a little later.

What is a Payday Loan?

The Consumer Financial Protection Bureau defines a payday loan as a short-term, high-cost loan, generally for $500 or less, that is typically due on your next payday. Payday loans are usually offered by payday lenders in a physical store but, depending on your state, they may also be offered online.

Why are they appealing?

        Payday loans are appealing because they are a pretty easy way to get money fast when you find yourself in a bind. Unlike credit cards and personal loans, payday lenders don’t take a person's credit score or credit history into account. Meaning the odds of being approved are extremely high. Because of this, people with ‘bad credit’ or ‘no credit’ are more likely to use this option. According to an article by American Progress, there are about 23,000 payday lenders—twice the number of McDonald’s restaurants in the United States—across the country.

 

How do Payday Loans work?

        As a borrower, you would go to the pay lender establishment to apply for the amount of money you need. Remember these are small dollar loans, so typically there is a cap on how much you can borrow but this varies from state to state, with the max amount generally between $350 to $1,000. After you are approved for the loan and understand the required fee (which can range from $10 -$30 for every $100 borrowed, depending on whether or not your state has put a cap on the maximum fee that lenders can charge), you would write a post-dated check for the full balance, including fees, usually for your next payday. Most payday loans are due two to four weeks from the date of the loan. (Note: You can also provide the lender with authorization to electronically debit (in other words ‘ withdraw’) the funds from your bank account.)  

        To illustrate let’s use an example. 

        Let’s say your car starts to have issues and after taking it to a shop, you find out repairs will cost you $500.

• You don’t have the money to pay for the repairs but need your car to get to work, so you decide to get a payday loan which you are approved for on September 4.
• Your payday lender charges a $20 fee for every $100 borrowed, meaning your interest rate is 20%. Since you’re borrowing $500, your fee would be $100 ($500 x .20 = $100). 
• Since the average repayment terms are two weeks, this means you would have to write a postdated check for September 18 in the amount of $600 ($500 for the loan + $100 for the fee).
  

        If you were to do the math, that’s an annual percentage interest rate (APR) of 521%! The average APR for payday loans is400% or higher. To help put this in perspective, the average APR for credit cards is between 15%-30% and the average APR for personal loans can range between 5% to 36%. This brings me to my next section.

Why are Payday Loans considered predatory? 

        There are a few reasons payday loans are considered to exploitative:

• Interest rate/fees. Compared to interest rates on credit cards and personal loans, the interest rate for a payday loan is astronomical. However, federal lawmakers are currently working to reduce payday loan rates from 400% to 36%. Ultimately, payday loans cost Americans more than $4 billion per year in fees alone.
• They tend to trap people in a payday loan cycle. Because of the high interest rates and the short repayment terms, people tend to get stuck in the vicious payday cycle. Think about it. Referring to the example above, if you weren’t able to pay $500 for your car repairs, then the probability that you’d be able to pay that amount, plus the fee within two weeks, are incredibly low. This usually causes people to have to ‘rollover’ or extend the loan. This is where the borrower will have to pay the interest on the loan or-in our example-$100 every two weeks, while the original balance remains outstanding. The average payday loan borrower is in debt for five months of the year and spends an average of $520 in fees to repeatedly borrow $375. 
• They tend to target vulnerable populations. This includes young people, people with low incomes who are generally making under $40,000 per year, and minorities. According to a 2018 CNBC survey, nearly 40 percent of 18-to 21-year-olds and 51 percent of Millennials have considered a payday loan. While a report published by The California Department of Business Oversight (DBO), found that while African Americans and Latinos made up almost 44% of the state's total population--those communities, on average nearly 60%, had six or more payday loan stores, compared to white communities at 28%.
  

 

Ways to avoid having to use a Payday Loan

• Start building your savings. This can help you avoid creating a debt in the event of an emergency. If you want to learn more on how to start a savings, check out my post ‘Save Me, Please!’.
• Work on building/fixing your credit. If you do find yourself in a bind financially, having access to credit can be a viable option to help you during your situation. While you will incur a debt, the interest rates and repayment terms on a credit card are more favorable than those of a payday loan. To learn how to build/fix your credit, check out my posts ‘Got Credit’ and ‘It’s Never Too Late, Fix Your Credit Now!’ 

 

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