The Debt Cycle

debt


For people with low incomes, meager savings and poor credit histories, a fast, easy cash loan might seem the best possible option when confronted with unforeseen expenses or budget shortfalls. But these loans can come at a very high price—one even higher than their already sky-high APRs. The price that borrowers pay when taking out a payday, pawn shop or title loan is the cost of a one-way ticket on the Cycle of Debt Express.

Here’s how the cycle of debt (also known as the debt trap) works:

Step 1: Bill needs a loan

Let’s say “Bill” needs a loan because he’s encountered some kind of unforeseen expense, like a mechanic’s bill or a surprise trip to the doctor’s office. Because Bill doesn’t have the cash on hand to meet this expense, he decides to take out a loan. And because Bill also A) needs the loan fast and B) doesn’t have good credit, he goes to their neighborhood payday loan storefront. He pays $60 to take out a $300 loan. The loan is due to be repaid 14 days later.

Step 2: Bill repays their loan.

Cut to two weeks later. Bill now owes $360 to the payday lender. However, once he pays the loan back, he finds that he now don’t have the money to afford another everyday expense. Let’s say that they used the loan to pay last month’s rent, which was due on the 1st. Now it’s the 15th and their electricity bill is due on the 20th. Since Bill doesn’t have that $60 that he paid to take out the loan (not the mention that $300 principal), now he can’t afford to pay that bill. So what does he do?

Step 3: Bill takes out another loan.

This time, it’s a $100 loan, which “only” costs Bill an additional $30. He takes out the loan, pays his electricity bill and moves on, but at the end of the month he must repay the $130 he borrowed and—wouldn’t you know it—he’s now short on their rent again. Since none of Bill’s friends or family can afford to loan him the money, he has no choice but to take out a third loan.

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