The kind folks over at Pew Trust did a great series on payday loans to help make them more understandable.
The videos help to explain the pros and cons of payday loans and why they can be helpful for some and incredibly expensive for most.
The payday loan issue is another one of those situations where when used appropriately it can be helpful, but most lenders and borrowers don’t use them appropriately.
The most reasonable use of the loan is if you will have the cash on hand, and available for repayment without impacting your future finances, on your next payday. For example, you have a surprise car repair you could afford to pay for with your next paycheck but you need to get the car repaired now. In that case a payday loan repaid in full the next time you get paid can be a cost effective way to borrow the money. It can certainly be less expensive than taking a cash advance on a credit card or even using an overdraft line of credit.
But research shows people are not using the loans like that. “The consumer-protection bureau found the typical borrower has full-time or part-time employment, with annual income in the $10,000 to $40,000 range.
The median borrower made 10 transactions, paid $458 in fees above the loan principal and remained in debt more than half of the year.
The majority of payday borrowers do not use the loans to cover an occasional gap, as promoters claim, but to manage chronic shortfalls. Whether the loan comes from a storefront operation or a bank, high fees with annualized percentage rates approaching 400 percent and the terms of repayment (usually in full with the next pay) exploit consumers who have few options.” – Source
Those sleazy looking payday stores are not the only ones in the payday loan business. Banks and credit unions are getting in the act as well.
Payday loans and the deposit advance loans offered by a small but growing number of banks and other depository institutions are generally similar in structure, purpose, and the consumer protection concerns they raise. Both are typically described as a way to bridge a cash flow shortage between paychecks or other income. They offer quick and easy accessibility, especially for consumers who may not qualify for other credit. The loans generally have three features: they are small-dollar amounts; borrowers must repay them quickly; and they require that a borrower repay the full amount or give lenders access to repayment through a claim on the borrower’s deposit account. – Source
Payday loans fall into the same boat as debt settlement or credit counseling, they are all tools that when used incorrectly can cause great harm.
The payday loan industry has not exhibited much, if any, self-regulation to prevent people from falling into the gerbil wheel of debt trap with these loans. It’s not in their best profit interest to do so and limit the number of loans generated or the fees they receive from revolvers.
And as more banks start playing the payday game, it’s not the bad neighborhood sleazy joints that will be the ones doing the harm. You’d think a bank would know better but they probably know profit better over responsibility.
Ironically while some payday loan borrowers turn to these type of loans to help avoid overdrafting their bank account, payday loan borrowers are more likely to overdraft because of the loan.