Payday Loans – Reasons to Avoid Payday Loans

Payday loans are cash advances for small amounts of money that are not secured with collateral. The interest rates are very high and the terms of repayment are short. A typical loan is for $500. The borrower often needs the money for basic necessities such as rent, utilities, food, or a medical bill. The name of the loan comes from the fact that it is supposed to be repaid with the borrower’s next paycheck. However, sometimes lenders will issue the loan anyway if they are confident that the borrower will have the money to repay it soon.

In the United States, payday loans are typically taken out by people in low-income neighborhoods who have poor credit and no other access to money. The interest rates on these loans are often nearly 400% on an annualized basis.

Payday lenders typically charge high interest rates because their customers are high-risk, but default rates are usually low. Many payday loan lenders have withdrawn from states that regulate interest rates.

Payday Loans Vs. Cash Advance Services

Though there are some key differences between the two services, from a consumer’s perspective, they share more similarities than differences. Both promise quick cash when you’re in a bind, provide the opportunity to borrow money to be repaid from the next paycheck, and have high interest rates.

For example, when a customer elects to put $50 in their account each week, that’s a voluntary payment that’s the equivalent of an annual rate of 26 percent. According to Lauren Saunders (Associate director of the National Consumer Law Center, a nonprofit consumer-advocacy organization), the biggest difference between payday loans and earned-wage services is pricing. She notes that payday loans are notorious for their high annual percentage rates, but says that the fees and voluntary payments commonly charged by earned-wage services, also known as “tips,” shouldn’t be ignored. For example, when a customer elects to put $50 in their account each week, that’s a voluntary payment that’s the equivalent of an annual rate of 26 percent.

Despite efforts by lawmakers to regulate them, payday loans are still legal in most states. Some states have no explicit interest caps at all.

While traditional payday lenders have been around for awhile, app-based cash advance services are relatively new. These services, also referred to as earned-wage, early-wage or payroll advances, are often provided by fintech startups, not traditional payday lenders. Most major providers, including Earnin, PayActiv and Dave, have sprouted up within the last decade.

Instead of charging loan financing fees, earned-wage advance services like Earnin and Dave request that users tip for their “free” cash advance. For example, Earnin suggests tips in dollar amounts up to $14 per advance, where Dave suggests a tip be 5%-15% of the total advance. Lastly, PayActiv markets itself to employers as a payroll benefit and makes money through membership and service fees.

Payday services tend to be used by people who are struggling financially. According to data from the Federal Deposit Insurance Corporation (FDIC), 8.9 million American households used services such as payday loans in the past year. These services are used more often by people who earn less money, showing that they are disproportionately affected by financial problems.

Some consumer groups maintain that people use payday loans and payroll advances for the same reason – they are short on cash and need help making it to their next paycheck. However, these groups also assert that these loans often do more harm than good by creating a “debt trap” or “cycle of debt” that can be difficult to escape.

When you borrow money against your next paycheck and you run out of money, it will be difficult to make it through the next pay period without having to borrow money again.

The spiraling effect can happen when you get paid and when you have to pay back a payday loan.

Who Uses Payday Loans?

The Community Financial Services Association of America estimates that there are 18,600 payday advance locations nationwide that have extended $38.5 billion in credit to 19 million households.

Since payday lending is easy to borrow and gives people quick access to cash, it is popular among consumers who don’t have other options for credit.

These lenders target people who are in a desperate situation and desperate people will do just about anything to get money. Payday lenders take advantage of people who are in dire circumstances and are willing to do anything to get money. These lenders don’t offer manageable repayment plans and are barely regulated.

Working people who are struggling to make ends meet are the target audience for payday lenders. These lenders advertise through various means, such as television, radio, online, and through the mail. The loans offered by payday lenders are advertised as helpful for unexpected emergencies; however, seven out of ten borrowers use them for recurring expenses such as rent and utilities.

Payday lenders offer loans that give customers access to cash immediately or loans that are based on post-dated checks. These loans are easy to get because lenders do not check credit histories, but the interest rates are very high. Customers who use this type of lending are often not very knowledgeable about finances.

In 2014 the Consumer Financial Protection Bureau, a federal government agency, issued a report showing that most payday loans are made to borrowers who renew their loans so many times they end up paying more in fees than the amount they originally borrowed. The average payday loan borrower spends $520 in fees for what originally was a $375 loan.

Despite the many documented dangers to consumers, the payday loan business in the US is still thriving in states that do not have limits on the amount of interest that can be charged. In 2008, a Dartmouth economist said that there were more payday loan outlets than McDonald’s restaurants and Starbucks coffee shops combined. However, there are now fewer states where payday loan lenders are able to operate, dropping from 44 in 2004 to only 36 in 2015, which may be a sign that the business is starting to retreat.

The decrease in business for payday loans has been significant. The nonprofit Center for Financial Services reported a 23.4% drop in revenue for storefront payday loans from 2014 to 2015. Nonbank online payday loans saw a decrease in revenue of 22.5% during the same period.

As payday loan revenue falls, subprime credit card issuers have increased their gains, keeping the overall level of subprime consumer lending relatively stable in recent years.

Cost of Payday Loans

The cost of borrowing can increase very quickly over a short period of time. People who are having financial difficulties might go back to the lender and say that they cannot afford to repay the loan, which is something that lenders actually want to hear. They will offer an extension, known as a roll over, which will give the borrower another two weeks to repay the loan with the condition that another fee must be paid.

If you roll over the loan after the first payment, you will owe an additional $30 on top of the $100 you already borrowed. After six months, the fees will amount to $180 plus the original loan, which will leave you in debt of $280. It is easy for borrowers to get stuck in a cycle of taking out new payday loans to pay off old ones, slowly sinking further into financial trouble.

Payday lenders are targeting new customers now that their old ones (poor people and military personnel) are no longer available to them.

Reasons to Avoid Payday Loans

Think before you borrow, remembering the financial pitfall implicit in payday borrowing:

• Payday Loans Are Very Expensive – High interest credit cards might charge borrowers an APR of 28 to 36%, but the average payday loan’s APR is commonly 398%.
• Payday Loans Are Financial Quicksand – Many borrowers are unable to repay the loan in the typical two-week repayment period. When it is due, they must borrow or pay another round in fees, sinking them deeper and deeper into debt.
• Borrowing from Short-Term Lenders Is too Easy – Unlike bank loans and credit card accounts, payday loans don’t require extensive paperwork. You can get one just by walking into a store, signing some papers and writing a check. And unlike other loans, once you sign the papers and take the money, you can’t change your mind since the loans commonly don’t contain a right of rescission.
• Some Payday Lenders Want the Right to Access Your Bank Account – They say it will save you the hassle of writing the commonly used post-dated check. But if the loan comes due and the funds aren’t in your account, the payday lender can make repeated attempts to withdraw the money, often resulting in multiple overdraft charges of $35 or more.
• Payday Lenders Can Be Ruthless Debt Collectors – If you can’t repay the loan, prepare for a barrage of tactics that includes late-night calls from debt collectors.

How To Avoid Payday Loans and Cash Advance Loans

Before taking out a loan, the Consumer Financial Protection Bureau recommends taking several steps to avoid getting into a long-term debt cycle. These steps include avoiding payday loans and earned-wage advances, as either one of these could trigger a financial crisis.

• Reach out to nonprofit organizations, community support groups, employers or friends and family for assistance
• Lower your payments due by negotiating with your creditor or debt collector
• If you have a solid credit history, contact your bank or credit union to apply for a credit card that have interest rates much lower than typical payday loans
• If you’re not in dire financial straits currently, start now on an emergency fund to beef up your contingency plan
• Beyond that, “avoid any promises of quick cash or places that do not look at any ability to repay loans,” Rios says.
• If you’ve exhausted all options, Saunders says to consider earned-wage or payroll advances before taking out a payday loan. Ideally, she says, the advance would be through companies like PayActiv, which provide the payroll services through your employer.

She states that using the Earnin or Dave apps is only a good idea if you know that your next paycheck will be more than usual. This way, you won’t have a gap in your income for your next paycheck.

Saunders said that if you are receiving a stimulus check and know that you will have extra money coming in, it is probably not a problem to take an advance on the check. However, he noted that this is an unusual situation.

She is saying that even though the new breed of fintech payroll lenders may seem safe, they are actually just businesses that are looking to make a profit, rather than help people.

Alternatives to Payday Loans

Though payday loan borrowers generally don’t think they can borrow money anywhere else, there are alternatives they should consider. Among them:

• Credit Unions and Small Loan Companies – Credit unions are a very good place to start looking for a small loan. Joining one has been made considerably easier and members serve as owners so they can be more lenient about qualification standards for loans. Some local lenders might be willing to loan small amounts at competitive rates, especially to businesses. Credit-card cash advances are another option. Though the interest rates are in the double digits, they are often considerably less than those available from payday lenders.
• Shop Before You Decide – Compare APRs and finance charges from all available sources. Alternative lenders might charge high rates, but might not impose the high loan rollover fees that payday lenders typically demand.
• Protect Yourself – Contact creditors or loan servicers if you can’t make a payment on time. They might be willing to work with you, offering a payment plan that might obviate the need for a payday loan.
• Get Credit Counseling – Non-profit agencies around the country offer credit advice at no or low cost to the borrower. To find a credit counseling agency, go online, talk to a credit union, housing authority manager or an employer’s personnel department for suggestions.
• Develop A Budget – Create a balance sheet with cash inflows and outflows. Knowing how much you have coming in and where you’re spending it is crucial to managing personal finances. Next, consider eliminating any expenses that aren’t crucial. For instance, cable is a good place to start eliminating expenses. Look for another provider or drop to a cheaper package. Keep in mind that it is a serious mistake to borrow at high interest rates to pay regular monthly expenses. If you can’t pay the rent without a loan, move to a cheaper place.
• Find Out If Your Checking Account Has Overdraft Protection – Protecting yourself against the credit damage that bounced checks cause is important. But it’s important to know what overdraft protection costs and what it covers.