A payday loan is typically a short-term loan of less than $500 typically aimed at low-income individuals. Fees usually run between $10 and $30 for each $100 borrowed. If you borrowed $300, for example, you'd owe between $30 and $90 in fees. Borrowers write a check for the amount of the loan, plus fees, to the lender dated for their next payday. The lender cashes the check on the borrower's payday and collects their principal and fees.
If you collect benefits from the Social Security Administration (SSA) and can verify your payments, you're typically eligible for a payday loan. Payday lenders welcome Social Security beneficiaries because, unlike part-time workers, their payments are stable and reliable. And for many people, including Social Security beneficiaries, the loans are fast and easy to get.
Convenience at a high cost
The convenience of payday loans comes with a high cost. A typical two-week payday loan with a fee of $15 per $100 borrowed equates to an annual percentage rate (APR) of almost 400 percent, according to the Consumer Financial Protection Bureau (CFPB). In contrast, the typical credit card has an APR of about 16 percent, according to Bankrate.com.
Some economists argue that payday loans can be a reasonable solution for short-term cash crunches, if you pay them off quickly. “The problem with these loans is when you pay off one loan and then you don't have enough money during the next pay period,” says Kimberly Blanton, who writes the Squared Away Blog for the Center for Retirement Research at Boston College. “And so you borrow more."
That's an expensive strategy. If in two weeks you can't afford to repay that $300 payday loan that came with $45 in fees, the borrower might suggest that you just pay the fees, rather than the principal of the loan. But by the next payday, you'd owe another $45 in fees plus the principal, meaning you'd now have paid $90 in just one month to borrow $300.
"The industry says, ‘Look, borrowers get to fix their car and go to work so they keep their jobs,” says Haydar Kurban, a professor of economics at Howard University. “The problem is someone who takes out 10, 12 loans a year. And the payday loan strategy is to land borrowers multiple times."
For recipients of Supplemental Security Income (SSI), a program run by SSA to support certain people with little or no income, there's an extra danger. A loan doesn't reduce your SSI benefit, but any funds you borrow and don't spend will count toward the $2,000 resource limit for an individual (or $3,000 for a couple) the next month. If the value of your resources is over the allowable limit at the beginning of the month, you cannot receive SSI for that month.
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A tempting choice in hard times
Payday lending jumps in hard times, and the U.S. economy has been crushed by the coronavirus. Although economic conditions have improved somewhat since the onset of the pandemic, when unemployment spiked to 14.7 percent, millions of Americans remain out of work, particularly those who held part-time or gig jobs. That's particularly bad news for those who rely on income from side work to supplement Social Security or SSI benefits.
When the economy is booming, demand for payday loans is lower. In 2010 about 4.6 percent of Social Security retirement recipients younger than 66 use payday loans, according to a 2019 paper by Kurban. About 5.9 percent of SSI recipients in the same age group use payday loans. (Payday loan use is generally lower for older Social Security and SSI beneficiaries.)
Will payday lending jump now that the economy is in recession? “I think that's a safe statement to make,” Kurban says. “Recessions are a time when people are looking for income, and when they lose that extra income, they resort to payday loans.” In 2010, as the country emerged from the worst recession since the Great Depression, about 6.2 percent of Social Security beneficiaries younger than 66 used payday loans, and a whopping 21.9 percent of SSI recipients used them, according to Kurban's paper.
Alternatives to payday loans
In 2017, the CFPB found that there were more payday lending stores than McDonald's restaurants. Kurban doubts that's still true: States govern payday lending rules, and states have been imposing stricter limits on the interest rates payday lenders can charge. Arizona, Arkansas, the District of Columbia, Georgia, New Mexico and North Carolina prohibit payday loans. Several other states limit payday interest rates at 36 percent. You can find the rules for payday loans in your state at the CFPB's page on payday loans.
Unfortunately, for people without a bank account, or people with poor credit, payday loans or other so-called alternative financial companies, such as pawnshops or auto title lenders, are often viewed as the only viable choice for money in a financial emergency. Nevertheless, you should seek as many alternatives as possible before considering a payday loan. Examples:
- Consider using AARP's Money Map, a step-by-step planner that will help you get control over debt and spending.
- Negotiate with creditors for more time or a lower payment. It's always best to get ahead of a payment problem with a creditor, particularly a utility or mortgage lender. Don't wait until you get shutoff or eviction notices.
- Ask friends or family for a loan. Borrowing money from people close to you can be difficult and even embarrassing, but if you're in a tight spot it might not hurt to ask. Be realistic about how long it will take to pay back the money.
- Try to start an emergency fund. Credit unions will often let you start small and add a few dollars weekly to a savings account. (They typically have better rates for savings accounts than banks do, too.) The catch: You have to have a credit union to join. The National Credit Union Administration has an online tool to help you find a credit union near you.