The Truth About Payday Loans

Payday LoansThe Kansas City Star recently reported that a single mother used a payday loan to borrow $300 for a trip to the dentist. When she couldn’t pay the loan two weeks later, she extended it and paid $50 twice a month for almost four months and still owed the entire principle amount.

A woman in North Carolina started with a payday loan of “$50 or $100,” and before she knew it, she was getting one loan to pay another and had racked up $700 in high-interest debt.

These are only two examples of the many people who get sucked into the irresistible rollover gimmick of pay day loans. Friendly store managers reportedly call customers to tell them how easy it is to defer repaying the loan on time by simple writing another postdated check.

What they don’t explain is the concept of compounding interest. And, as I’ve mentioned before, those who understand compound interest are destined to collect it. Those who don’t are doomed to pay it.

Payday loans are short-term cash loans. Borrowers typically write a personal check for the amount borrowed plus the finance charge and receive cash or sign over electronic access to their bank accounts to receive and repay payday loans. On the next payday the loan and finance charge must be paid in one lump sum.

Payday loans can range in size from $100 to $1,000, depending on state legal maximums. The average loan term is about two-weeks and loans cost on average 470% annual interest (APR). Finance charges normally range from $15 to $30 to borrow $100. For two-week loans, these finance charges result in interest rates from 390% to 780% APR. Shorter term loans can have even higher APRs.

Borrowers who obtain payday loans generally have cash flow difficulties, and feel that they have few, if any, lower-cost borrowing alternatives. All they need to get a payday loan is an open bank account in relatively good standing, a steady source of income, and some identification. Lenders do not conduct a full credit check or ask questions to determine if a borrower can afford to repay the loan.

At the end of 2006, The Center for Responsible Lending reported about 25,000 payday loan outlets in the United States and annual loan volume of at least $28 billion, with almost $5 billion in loan fees being paid by consumers.

As the examples have shown, payday loans trap consumers in repeat borrowing cycles due to the extreme high cost to borrow, the very short repayment term, and the consequences of failing to make good on the loan amount. Consumers who use payday loans have an average of eight to thirteen loans per year at a single lender.

Under the Truth in Lending Act, the cost of payday loans must be disclosed to the consumer. Among other information, you must receive, in writing, the finance charge (a dollar amount) and the annual percentage rate or APR (the cost of credit on a yearly basis). However, in a Consumer Federation of America (CFA) survey of 100 Internet payday loan sites, only 38 sites disclosed the annual interest rates for loans prior to customers completing the application process, and only 57 sites quoted the finance charge.

Internet payday lending adds security and fraud risks to payday loans. The CFA warns consumers to exercise extreme caution when using Internet payday loan sites. According to the CFA, small loans involving electronic access to consumers’ checking accounts pose high risks to consumers who borrow money by transmitting personal financial information via the Internet.

Contracts from Internet payday lenders often include a range of one-sided terms, such as mandatory arbitration clauses, agreements not to participate in class action lawsuits, and agreements not to file for bankruptcy. Some lenders require applicants to agree to keep their bank accounts open until loans are repaid.

If you need credit, a payday loan is probably the last place you want to look. Consider other options first such as a small loan from your credit union or small loan company, an advance on pay from your employer, or a loan from family or friends. A cash advance on a credit card may also be a possibility, but you’ll want to understand the terms before going that route.

If you ignore everything I have just said, and still feel that you must use a payday loan, please, for the love, borrow only as much as you can afford to completely pay off with your next paycheck while still having enough left to make it to the next payday.

5 thoughts on “The Truth About Payday Loans

  1. Great job on that post. Payday loans are the next horrible thing to hit this world. Same with car title loans or house title loans.

    If anyone is considering these types of loans I would strongly suggest looking at Prosper.com. You dont get the money as fast, but you can get more and make payments to pay it off in 3 years. Also interest rates will be lower and you would be supporting the PF/Prosper blogosphere.

    -John

  2. Clint, you come up with very useful information.

    You have revealed the exact pros and cons of payday loans from every possible angle by providing real examples. I also feel that we should only avail the payday loans when absolutely necessary, otherwise it would be better if we try to avoid them as much as possible.

    Jeff Clair

  3. Faxless payday loans or cash advance loans are one of the more frequently used ways to get emergency cash until the next payday. It is also known as instant cash advance and is very easy to apply for.

  4. Although payday loan may look very expensive, but does APR really make any sense when considering short term loans. When you go to a hotel you dont ask the rent for a whole year. Similarly the concept of “annualized” interest rate doesn’t make sense when short terms loans are considered. And also the ease of availability makes them a very good option for emergencies.

  5. payday loans are a nightmare . All you have too do is step into one STAR LOANS to be exact –I WAS CONED BIG TIME INTO RENEWING MY LOAN . WHEN ALL I WANTED TOO DO WAS CHANGE MY PAYMENT DATE BY A WEEK ,NEXT THING I KNEW I HAD GIVEN STAR LOANS A CHECK FOR 90.00 DOLLARS. THINKING IT WAS A PAYMENT, WELL IT TURNED OUT TOO BE A ROLLOVER SCAM . I COULD HAVE JUST PAID THE 10.00 DOLLAR LATE CHARGE BUT THE FAST TALKING MANAGER FIXED ME UP WITH A NEW CONTRACT. AND THE 90.00 DOLLARS WENT TOO INTREST FEES. OH BOY NOWI DON,T KNOW IF A LAWYER CAN HELP ME OR NOT , BUT STAR LOAN MANAGER IN PORTER TX PULLED A FAST ONE , THAN HAD THE NERVE TOO BOOST THAT SHE DID ME A FAVOR. OH WELL WE LIVE AND LEARN, GOT 516, IN CASH AND OWE BACK 826.00 WOW

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