Payday lenders have never had a great reputation. Often operating out of neon-lit storefronts in hard-up neighborhoods, they’re known for saddling borrowers with spiraling debt on short-term loans.
But when they go online, payday lenders may pose an even greater risk to needy Americans.
“Unlike a payday loan that you might get from a local business, online payday loans require your bank account number,” says Stephen A. Cox, president of the Council of Better Business Bureaus. “As a result, the borrower is at the mercy of the lender as more money than he counted on is withdrawn from his account.”
Why are the withdrawals so high? Some online payday lenders charge outrageous interest rates—up to 800 percent—claiming they are exempt from state usury laws, which cap rates, because they operate from Native American reservations that are “sovereign nations.”
The BBB has been flooded with complaints from consumers who tell similar stories. They take out small short-term loans. Then the vicious cycle begins: Their payments go toward recurring finance charges, not the principal, and they wind up paying many times the original amount.
Many online payday lenders are not licensed, and use the “sovereign nation” claim as a reason they don’t have to be, according to the BBB and others.
“Internet payday loan providers are the loan sharks of today,” says West Virginia Attorney General Darrell McGraw, who last year sued a dozen Internet payday lenders.
In his state, some online lenders were charging residents interest rates more than 45 times higher than the legal 18 percent cap. McGraw also found that some lenders who claimed tribal sovereignty were not actually members of the tribe, but were merely renting space to claim shelter from state and federal laws.
Historically, payday loans have been short-term and for small amounts—in theory, money to tide you over to the next paycheck. The typical payday loan is for $325, with a repayment period of two weeks. But with high fees, that payback can become $377 by day 14. If a borrower cannot pay it, the loan is extended with more fees. Alternatively, an additional loan may be made, a practice known as a loan flip.
Skirting the Law
In the end, reports the nonprofit Center for Responsible Lending, the average payday borrower of $325 ends up repaying $793.
With online payday lenders who skirt the law, the situation can be even worse. One Massachusetts woman paid $1,700 on a $225 loan she received from Ace Cash Services, reports the BBB. A Pennsylvanian said he was charged a 547 percent interest rate on a $300 loan by a lender called United Cash Loans. Both agencies claim they are based at the same address on an Oklahoma reservation.
How to Protect Yourself
Think twice before borrowing from any payday lender—especially an Internet-based firm. “The bottom line here,” says Cox, “is that if you are handing over your bank account information online to get a payday loan without doing your research, you are setting yourself up to pay hundreds and even thousands of dollars more than you bargained for.”
A better strategy: Look into a home equity line of credit or another loan from your bank. Better yet, try to establish an emergency savings fund. “Our data show that families [earning] $25,000 a year are eight times more likely to take payday loans when they have no savings as compared to having just $500 in savings,” says Jean Ann Fox of the Consumer Federation of America, a nonprofit advocacy group.
If you must use a payday lender, be sure you’ll be able to quickly repay the debt. And beware of these red-flag warnings: lenders who give sketchy information about their location or contact information, those who don’t ask for any background information other than your bank account number, or those with poor ratings from the BBB.