Payday Loans

Payday Loans
A payday loan is an unsecured, small-dollar, predatory personal loan that comes with short repayment terms and very high interest rates.

Why is it called a “Payday” Loan?

Payday loans have an average term of 14 days and are rarely taken out for longer than a month.(1) Allegedly, they’re intended to tide a person over until their next payday. That’s how they got their name. Payday lenders will simply set the due date for the loan on the borrower’s next payday. Payday loans are also known as “cash advance loan.”

What is the average size of a Payday Loan?

According to the Consumer Financial Protection Bureau (CFPB), the average amount for a payday loan is $350. While the amount that a payday lender is allowed to loan out varies state to state, the average per-loan limit is $500.(2)

How does a Payday Loan work?

The two most important features of a payday loan are the length of the term and the interest rate. Payday loans average 14 days in length. It depends on which state the loan is being issued in, but payday loans rarely come with terms longer than a month — some have terms as short as a week.

When it comes to cost, there are two numbers to know: the interest charged and the fee. The interest is usually expressed as a percentage of the amount borrowed whereas the fee is a flat rate. For example: a $100 payday loan with a $20 fee and a 10% interest rate would cost $30 to borrow. That’s an overall rate of 30%.

30% might seem like a reasonable rate, but taking a look at the loan’s Annual Percentage Rate (APR) will prove just how expensive the loan actually is.

What’s an Annual Percentage Rate (APR)?

The annual percentage rate measures how much a loan would cost if it were outstanding for a full year. The rate includes interest as well as additional fees, which makes it a much better measure of cost than the simple interest rate. It’s a standardized measure that allows people to accurately compare the cost of different loans and credit cards.(3)

How much does a Payday Loan cost?

The answer to this question is going to vary, both from lender to lender and from state to state. All states regulate payday loans differently; some have standards so strict that payday loans are outlawed all together, while others have barely any regulations at all. However, it is fair to say that a payday loan is often the most expensive way to legally borrow money that you’re going to find.

Let’s look at our previous example: a $100 payday loan with a $20 fee and a 10% interest rate, which adds up to an overall cost of 30%. Let’s say that it also has a 14-day term, as that’s the average length for a payday loan.

While the interest rate for this loan is only 10%, and the overall cost is only 30%, the APR for this loan is 780%.

How are Payday Loans repaid?

Borrowers can take out payday loans from storefront or online lenders. In most cases, the borrower will write out a post-dated check to the lender for the amount owed plus fees and interest. The lender then gives the borrower cash and waits until the agreed-upon due date to cash the check.(4)

Sometimes the borrower will have to go back to the payday lender on or before the due date in order to make the payment in person. In other instances — especially with online payday loans — the borrower gives the lender the information for their checking account. This allows the lender to have the funds automatically withdrawn once the loan comes due.

What is a predatory loan?

A predatory loan is a loan that takes advantage of the borrower, often through very high rates, hidden fees and misleading terms.(5) With a predatory loan, the borrower usually ends up being unable to pay what they owe, at which point the lender can put them through aggressive collections, garnish their wages, and even seize their assets depending on the terms of the loan.

Predatory loans are usually issued to people who have poor credit histories and/or low credit scores. These people have less access to credit than other borrowers and are shut out from traditional lenders like banks or credit unions. Due to their lack of options, these borrowers are seen as being easier targets by predatory lenders; they have little choice but to accept.

Payday loans are often described as predatory loans, as are title and pawn shop loans. Any kind of loan can be predatory, depending on the terms, but many see payday and title loans as predatory by nature because they’re designed to trap customers in cycles of debt.

How does a cycle of debt work?

When a person is in a cycle of debt, also known as a “debt trap”, it is because they have to continually borrow money to pay back old debts or meet everyday expenses.

The cycle generally works like this: A person has an upcoming bill or expense that they do not have the money to meet, so they borrow money in order to pay it off. And borrowing money means that they have to pay fees and interest. And paying off those fees and interest means that they have even less money in the future, meaning that they have to borrow money again in order to meet expenses.

A common way that a person could end up in a debt cycle is by paying off a loan using money that should be going towards their rent or their car payment, etc. The person then takes out a new loan in order to make those payments. When it comes time for that new loan to get paid off, they find themselves right back where they began.

Instead of relying on payday loans as a one-time source of quick cash to pay unforeseen or emergency expenses, people use them on a regular basis to cover their everyday cost of living. The lending practice that most enables this kind of debt trap is called “loan rollover.”

What is a loan rollover?

To rollover a loan means that the lender extends the terms of the loan in return for charging the borrower an additional fee.(6) Generally, the length extension is equal to the original term; for instance, a 14-day loan would be extended for another 14 days. Likewise, the fee charged is usually equal to the original finance charge: so a loan with a $50 finance charge would cost another $50 to roll over.  In some instances, the lender will require that the borrower pay the finance charge on the original loan before issuing the extension.

Rolling over a loan gives the borrower more time to pay back the loan, but it also means that they now owe more than they previously did. This increased cost means that sometimes they still cannot afford to pay back the loan, even though they’ve been given more time. So when the loan comes due, they roll it over again. This continues on until they owe far more on the loan than they could ever hope to repay.

Situations like this can end with lenders taking the borrowers to court or passing them off to a collections agency. Frequently, borrowers face wage garnishment — sometimes for years at a time — in order to pay back what they owe. In Texas, defaulting on a payday loan could even land a person in jail.(7)

How are Payday Loans regulated?

Payday loans are subject to state regulations, which means that their size, cost, and availability are going to be different depending on what state you live in. In some states, payday loans are illegal, while in others, they’re barely regulated at all.

Some ways that states regulate payday loans include:

  • Size Caps: This is a maximum limit on how much money the lender can issue to the borrower. Some laws limit how much can be lent based on the borrower’s monthly income, while others set a hard cap that applies to all borrowers. $500 is the common limit for a payday loan.
  • Price Caps: This is a maximum limit on how much the lender can charge the borrower to get a loan. In some states, they cap the loan’s APR. In other states, they set a certain dollar-limit per $100 borrowed. For instance, a lender could be prohibited from charging more than $10 per $100 borrowed. However, the APR for a 14-day loan at this rate would still be 260%.
  • Term Limits: While some states set a maximum time period for payday loans, many more focus on setting minimum periods. This gives people more time to pay back the loan. Some states vary the term limits based on the borrower’s pay period.
  • Rollover Bans/Limits: Many states have banned rollover entirely, while other states set limits on how many times a loan can be rolled over before it has to be repaid. However, some lenders (and borrowers) can get around these laws by simply taking out a new loan immediately after paying off the old one.
  • Cooling-Off Periods: This limits how quickly a person can take out a new loan after paying off their old one. Generally, cooling-off periods last anywhere from 1-10 days. The periods can also vary depending on how many consecutive loans a person has taken out, or how many they’ve taken out in a given year.
  • Limits on Simultaneous Loans: This limits how many loans a person can have outstanding at any one time. Some limit the number of loans they can receive from a single lender, while others limit the total number of loans they can borrow from any lender. In order for these regulations to work, states that have them often have to set up a state-wide loan database.
  • Extended Repayment Periods: These laws allow customers to pay off their loans over a longer period of time, instead of in one lump sum. They often only apply in certain circumstances, such as after a certain number of rollovers.(8)

What are good alternatives to a Payday Loan?

Since a payday loan is oftentimes the most expensive way you can find to borrow money, a better alternative is… pretty much anything else. However, some alternative funding methods — such as using a pawnshop loan or a credit card cash advance — are almost as expensive as a payday loan or carry substantial risks of their own. Here are some of the best alternatives out there to taking out an expensive payday loan:

  • Personal Installment Loans from OppLoans: Unlike payday loans, a personal installment loan from OppLoans comes with a series of regular, fixed payments that let you pay back your loan over time. Plus, our rates are 70-125% lower than other personal lenders. We offer loans from $1,000-$10,000 with terms between 6 and 36 months. Our payments are often scheduled on a monthly or bi-weekly basis, and our rates are fixed, which means that the amount you pay will never change.
  • Payday Alternative Loans: These loans are only available to credit union members whose credit unions are a part of the National Credit Union Administration (NCUA). The loans are between $200 and $1000 and come with terms between 1 and 6 months. The rates and fees on these are much lower than your typical payday loan and they cannot be rolled over. However, one must have been a member of a credit union for at least a month in order to qualify for the loan.(9)
  • Payroll Advance: Some employers will give their employees an advance on their upcoming paycheck in order to cover emergency expenses. The amount advanced is simply deducted from their next paycheck, and this option usually doesn’t come with any interest or fees. This option will depend on your employer’s policies as well as your own standing as an employee.(10)
  • Deposit Advance: Some banks and credit unions allow people to borrow money against their future deposits. If you have a regular bank deposit such as a paycheck or government benefits, your banking institution might advance you money, then deduct what’s owed from that future deposit. Unlike payroll advances, these usually do come with fees and interest — and while the rates are lower than payday loans, they can still be quite high.
  • Borrow from Friends or Family: This option is pretty self-explanatory. Instead of getting a loan from a bank, you could get one from a friend or relative. Depending on your relationship with them, they might charge you a low interest rate; they might even charge you nothing! The risk here, obviously, is potential damage to your personal or familial relationship if you have trouble paying them back. To protect against this, it’s a good idea to get a written agreement between both parties — some even go so far as to have the agreement notarized.(11)

References:

  1. “Payday Loan.” Investopedia. Investopedia.com Accessed May 16, 2016.
  2. “How Payday Loans Work.” Payday Loan Consumer Information. PaydayLoanInfo.org Accessed May 16, 2016.
  3. “What is the difference between an online payday lender and one with a storefront?”ConsumerFinancialProtectionBureau.gov Accessed May 11, 2016.
  4. “Annual Percentage Rate – APR.” Investopedia. Investopedia.com Accessed May 16, 2016.
  5. “How do I Repay a Payday Loan?” Ask CFPB. Consumer Financial Protection Bureau.ConsumerFinance.gov Accessed May 11, 2016.
  6. “Predatory Lending.” Investopedia. Investopedia.com Accessed May 11, 2016.
  7. “What does it mean to renew or roll over a payday loan?” Ask CFPB. Consumer Financial Protection Bureau. ConsumerFinance.gov Accessed May 16, 2016.
  8. Hicken, Melanie. “In Texas, payday lenders are getting borrowers arrested.” CNN Money. January 8, 2015. Money.CNN.com Accessed May 16, 2016.
  9. Kaufman, Alex. “Payday Lending Regulation.” Finance and Economics Discussion Series Divisions of Research & Statistics and Monetary Affairs, Federal Reserve Board, Washington, D.C. August 15, 2013. FederalReserve.gov Accessed May 16, 2016.
  10. “Payday Loan Alternatives.” MyCreditUnion.gov. MyCreditUnion.gov Accessed May 16, 2016.
  11. Starbuck Crone, Emily. “Alternatives to Payday Loans Can Help You Dodge Debt Trap.” Nerdwallet. March 11, 2015. Nerdwallet.com Accessed May 16, 2016.