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Facts On Payday Loans: What You Need To Know

On January 31, 2011

Fact: Each year, 12 million Americans are trapped in a cycle of high interest rate payday loans. Many people who enter into payday loan agreements do not know what they are getting into.

If you’ve ever been in a position where you need money quickly with poor credit, you might have considered taking out a payday loan. These loans are popular amongst people who are struggling financially because they are quick and easy to get, and there’s no waiting on the money. In spite of the simplicity of payday loans, there are tons of reasons to avoid them. It’s important to understand the truth about payday loans before deciding to apply for one.

What exactly is a payday loan?

A payday loan is a type of short-term loan. The term “payday” refers to the fact that most lenders offering them want the money paid back plus interest by the borrower’s next payday. For this reason, it is usually not possible to borrow a large sum of money when taking out a payday loan. Most of these lenders deal only in small loans, usually around $1000 or less. Taking out a $5000 payday loan is not realistic under most circumstances.

What does the application process involve?

The application process for payday loans tends to vary amongst different lenders, but the requirements are almost always the same. To take out a loan, you normally have to provide: 1) proof of employment, and 2) checking account information.

The proof of employment is necessary so that the lender will know how much you earn, which helps them determine how much you can borrow. Your checking account information is needed so that the lender can automatically draft the funds out of your account on the payment due date.

Unlike with other loans, you are generally not required to submit to a credit check when taking out a payday loan. There is additionally no need for a cosigner with payday loans.

Understanding the Terms of a Payday Loan

You should always familiarize yourself with the terms of any potential payday loan you’re getting. If a specific lending office doesn’t want to disclose all interest rates and fees, that should raise an immediate red flag. A place that asks for your address, phone number, or social security number before even discussing loans/options should raise a red flag. Shady lending companies often fail to provide details regarding loan terms – usually because they’re breaking a few laws. A company that is reputable should have no problem providing any information that is requested.

Interest Rates On Payday Loans Are Insanely High - Short-Term Solutions Become Long-Term Problems

Before signing on the dotted line, a person considering a loan from a payday lender should ask himself if he really needs the money. The fact is that even the most reputable lenders operating in these circles are taking advantage of people who are already down on their luck. Getting the money is quick and easy, but even the quickest payday loan has to be paid back and then some. MSNBC News recently shared a few horror stories of well-intentioned borrowers who essentially became victims of the payday loan cycle, including one in which a woman discovered she was being charged an illegal rate of 800 percent interest. She was nearly ruined financially before filing complaints and putting a stop to the collection activity.

Interest rates on payday loans vary from lender to lender, but they are always incredibly high. It is not uncommon to be charged between 600 and 900 percent on the average payday loan. In addition to the astoundingly high interest rates, you can expect to be charged other fees — particularly if your payment on the loan is drafted out of your bank account and the funds are not there. When this happens, it’s likely that your bank will also charge you an insufficient funds fee.

Should Payday Loans Should Be Avoided?

In most cases, taking out a payday loan will hurt you long-term even though it may seem to help you short-term. The usual scenario goes something like this:

A man with poor credit and no money is $200 short on his light bill for the month. The cut-off day is coming up, and he needs to find a way to keep his power turned on. He decides to take out a short-term payday loan for $200 to get the power company paid so he can keep his lights on.

The payday lending office is more than happy to loan him the money because he has check stubs proving he brings home an average amount of $500 per week, and he also has a checking account at a local bank. The man gets the money from the lending office, agreeing to allow them to draft $240 the next week out of his checking account ($200 for the loan amount plus $20 for each $100 borrowed).

In his desperation to keep his power turned on, this man has forgotten that he missed a few days of work the week before, meaning his check will be significantly lower than normal. He ends up only bringing home $320 the next week, and his wife immediately spends $100 of that at the grocery store as soon as the funds have been deposited into the bank. On her way home, she fills the car up with gas using a debit card attached to their checking account.

That same day, the payday lending office drafts the $240 out of the account, ultimately overdrawing this man because he doesn’t have that much in there after spending money on basic necessities like groceries and gas. As a result of this overdraft, the man now owes the payday lending office more than he originally did thanks to their penalty fees for no availability of funds, and he also owes the bank insufficient funds fees.

He’s in more financial trouble than he was in to start with, so he visits another payday lending office to borrow even more money to pay back the first payday loan office and to take care of his bank overdraft.

As you can probably see, the payday loan process can turn into a vicious, never-ending cycle. In fact, this is great for lenders! A July 2009 report by the Center for Responsible Lending found that:

Here is a video from the Center for Responsible Lending summarizing these reports:

Payday Lenders Are Slowly Becoming Banned

Many states have caps on interest rates, making it very hard for payday lenders to operate legally seeing as how they charge such astronomical amounts of interest. In fact, some states have completely banned payday lenders altogether. As of 2007, payday loans in Georgia are no longer legal, and many other states are beginning to follow suit.

What states do not allow payday loans?

Using the state information database at the Consumer Federation of America’s payday lending resource, we’ve compiled a list of states that do not allow payday loans or payday lending:

Arizona
Connecticut
Washington DC
Georgia
Maine
Maryland
Massachusetts
New Jersey
New York
North Carolina
Pennsylvania
Vermont
West Virginia

Honest and Trustworthy Payday Lending – Do Reputable Payday Loans Exist?

If you are looking at getting a payday loan and want to find a reputable payday lender, there just may be an option for you. Back in 2007 the New York Times highlighted a company called GoodMoney. GoodMoney is a partnership between Prospera Credit Union, and Goodwill. The article mentioned that 62 percent of borrowers with GoodMoney took fewer loans than the industry average. GoodMoney is actually a nonprofit lending service – where 50% of the fees associated with loans borrowed ($9.90 per $100 borrowed) go towards writing off bad loans, and the other 50% goes towards administrative costs and operations. Keep in mind that most other payday lenders charge upwards of $15-25 per $100 borrowed.

Regardless of low fees and a “nonprofit” lender — taking out payday loans means that you take on an obligation to pay your debts as well as fees/interest.

Alternatives To Payday Loans If You Have Bad Credit

If you’re considering a payday loan because you need money quickly and you have a poor credit score, there are a few alternatives you could consider first.

  1. Even though you may think you won’t qualify for a loan through traditional means — such as a bank or non-payday lending office — you should at least try. You might be surprised to discover that you will be loaned the money you need. It’s almost certain that your interest rate will still be high if your credit is not good, but it most definitely won’t be as high as what you can expect from a payday lender.
  2. You might also want to think about whether or not you actually need a loan. Are you trying to pay off a debt or bill? The Federal Trade Commission recommends contacting the people or companies you owe money to and asking if you can have more time to pay them back instead of taking out short term signature loans through payday lending offices. If there’s even a small chance that you’ll be given more time, it’s worth asking about to avoid getting sucked into the payday loan cycle. You may be hesitant to speak with your creditors regarding past due payments when you don’t have any money, but it’s generally better to stay in contact with them about your financial situation. Your creditors will be much less likely to take action against you if you’re not avoiding them.

Resources/Sources:

Center for Responsible Lending: Beyond The Myths About Payday Loans
FTC Consumer Alert on Payday Loans

 
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