What Are Payday Loans Used For?
Inside Subprime: Jan 27, 2019
By Lindsay Frankel
12 million people choose to take out payday loans each year, raking in more than $7 billion for the payday lending industry. On average, borrowers spend more on interest than they initially received in credit. And while payday lenders advertise payday loans as a quick-fix solution to cover an emergency expense, that is rarely how these loans are used.
According to a report from Pew Charitable Trusts, 69 percent of borrowers said they first took out a payday loan to help with a recurring expense. Of those, 10 percent used a payday loan to cover rent or a mortgage payment, and 5 percent put the money towards groceries. The rest used the loan to help with regular expenses, such as utility bills, car payments, or credit card payments. Only 16 percent said they used their first payday loan to afford an emergency expense. For example, one borrower reported using a payday loan to get his car fixed.
Payday loans are short-term loans intended to be repaid on the borrower’s next payday. But the average payday loan has an annual percentage rate reaching almost 400 percent, which makes these loans unaffordable for most borrowers, and often impossible to pay back in the time allotted. When borrowers renew their payday loans, interest and fees pile on.
“Payday loans are marketed as an appealing short-term option, but that does not reflect reality. Paying them off in just two weeks is unaffordable for most borrowers, who become indebted long-term,” said Nick Bourke, Pew’s director of consumer finance. “The loans initially provide relief, but they become a hardship. By a three-to-one margin, borrowers want more regulation of these products.”
So why do borrowers choose to use such a risky product, instead of using alternative resources? Another Pew survey found that many borrowers are desperate, with 37 percent indicating they would take a payday loan regardless of the terms. Some borrowers would prefer to use a loan than ask friends or family for help, and others have an inaccurate perception of payday loans, believing they do not create ongoing debt and are preferable to other penalties such as overdraft fees.
But lump sum repayment of a payday loan is far from affordable for most borrowers. The average borrower can only afford to pay $50 towards a payday loan, while the average payday loan requires a $400 payment within two weeks. That’s why more than 80 percent of payday loans get renewed or rolled over within two weeks, and the average borrower spends five months out of the year in debt due to payday loans.
When payday loan borrowers struggle to make ends meet while paying the exorbitant interest and fees associated with their loans, they are often forced to use the options they were trying to avoid when they first borrowed money. Most borrowers end up paying for overdraft fees, even if they initially took out a payday loan to avoid these fees. And 41 percent need to get help from family and friends, a pawn shop, another loan source, or a tax refund to get out of debt.
If you are considering taking out a payday loan, explore other alternatives first. It might be difficult to ask for help, but it’s better to get help now than to ask for assistance getting out from under an expensive payday loan in the future. And there are less costly options for borrowing, even if you have bad credit. Installment loans have lower interest rates and longer terms that make them a more responsible choice for borrowers, and banks and credit unions provide alternatives as well.