Payday Loans Don't Pay
When Nancy needed $200 to pay bills, she borrowed it from a payday lender who charged her a fee of $38 for a two-week loan. On her next payday, she still couldn't meet her expenses and returned to the payday lender. She had to pay the $38 charge again to extend or "roll over" her loan for an additional two weeks. As the weeks went by, she returned to that lender 11 more times and saw the fees mount up. After six months, she had paid almost $500 in fees and still owed the original $200!
How They Work
Check cashers, pawn shops, gas stations, Internet companies and others make small, short-term, and very high-interest-rate loans that go by a variety of names: "payday loans," "cash advance loans," "check advance loans," postdated check loans," or "deferred-deposit check loans." Most often, you write a personal check payable to the lender for the amount you wish to borrow plus a fee. The check is dated for your next payday or another day within the next couple of weeks when you have to repay the loan. At that time you usually have three options: let the lender deposit your check automatically, pay the lender in cash equal to the amount of the check, or roll over the loan and pay the fee again.
While payday lenders make it easy to get the cash you need, try to avoid them. Their convenience comes at a very high price. The typical fee for a $100 two-week payday loan is $15. When figured over a year, that's a 391% annual percentage rate (APR). Compare that to the 18% APR of the average credit card.
Consider the Risks
A payday loan costs at least ten times as much as a small loan from a traditional bank. You may end up paying an APR of 300%, 400% or even 1,000%.
If your check to the payday lender bounces, both the bank and your lender may charge you bounced check fees. In some states, a payday lender might threaten you with prosecution for writing a "hot" check (even though the lender knew that you didn't have enough money in your account when it accepted your check).
If you can't repay the loan and the fee on the due date, you may get trapped in an endless cycle of debt: you are never able to pay off the loan, but you are repaying the loan fee over and over. Payday loan customers average more than 10 loans per year.
Like Nancy, you may end up paying much more in fees than the amount you borrowed originally.
Alternatives to Payday Loans
Contact your creditors to see if they will give you more time to pay your bills. That way you can pay them when you have the funds available.
Borrow from a friend or family member.
If a loan is unavoidable, shop around. Although payday loans may be the only option for certain borrowers with poor credit, you may be able to find a bank or credit union that will approve a small loan with a reasonable interest rate. Compare both the APR and the dollar amount of the finance charge.
Consider getting overdraft protection on your bank account. You will avoid returned check fees and have a cushion in financial emergencies.
If you own a credit card, try taking a small cash advance.
Preventing Financial Emergencies
If you find you are just a little short of cash each month or can't pay unexpected bills, take a hard look at your income and expenses. Is there any way that you can develop a modest savings plan? If you track where you spend your money, you may find ways to save. Are there some purchases you don't have to make?
With just $300 in a savings account, you may be able to handle a financial emergency without going to a payday lender. In addition to avoiding high payday loan fees, you will be able to earn interest on your money until you need it.
If you need help preparing a budget, you can get it from a nonprofit credit-counseling agency or cooperative extension agent in your area. Carefully shop for credit-counseling agencies. Some disreputable ones have only dug consumers in deeper. The Federal Trade Commission has cracked down on some of the companies that took money with the promise of paying off bills, and then simply pocketed the cash. Avoid any agency that says it uses your first month's payment to creditors for its own fee or as a "voluntary contribution." Check with your state Attorney General first, to find out if complains have been made about the agency’s practices.
Additional Resources
Credit Counseling Agencies Approved By Bankruptcy Trustees
Under the latest bankruptcy reform, consumers must get credit counseling before filing for bankruptcy. The U.S. Trustees Program, a Department of Justice group that works to improve the bankruptcy system, lists approved credit counsel agencies. Even if you are not considering bankruptcy, you can consult with these agencies.
National Foundation for Credit Counseling
The NFCC is a nationwide network of nonprofit budget and debt-counseling agencies. The agencies provide educational programs and individual counseling in-person, by phone, or by mail. They teach basic money management skills and assist in resolving debt problems. Consumers may obtain counseling services at no cost or for a low fee.
Association of Independent Consumer Credit Counseling Agencies
AICCCA maintains a searchable list of its member agencies.
Before You Enter a Check Cashing Store
Learn ways to avoid the high fees charged by check cashing services.
Some lenders take advantage of financially distressed borrowers.
Suggestions of ways to tame the debt cycle.
