Payday Loans Exposed: How 'Short-Term' Lenders Create Long-Term Troubles

Payday Loans Exposed: How 'Short-Term' Lenders Create Long-Term TroublesThe Center for Responsible Lending has released a new report about payday loans, and the picture it paints is seriously depressing. What's worse is that the report published Thursday actually understates the grim reality facing payday borrowers today.

For the uninitiated, a payday loan is a particularly expensive way to pay bills. In principle, the idea is simple: The company lends the borrower money for whatever their immediate need is, charges a fee, and then a few days later, on payday, the borrower pays the loan back in full.

If that were all that happened, it would be hard to see the harm. That's why the industry markets itself as a type of very short-term credit. The industry's trade group counsels: "[A] payday advance is inappropriate when used as a long-term credit solution for ongoing budget management." But the report found that only 15% of payday borrowers were one-time users.

In fact, the CRL documented that payday loans don't usually end on that first payday. The center tracked 11,000 borrowers for two years, and even including the one-time users, found that during those two years, the borrowers on average had a payday loan out for more than a year. Moreover, the report found that 90% of the time a new loan was taken, it was taken out during the same pay cycle the last one was repaid, essentially rolling over the debt.

Payday loans have to be paid back in full at the end of each payday cycle, which tends to leave the borrower short the next week, so she takes out a new payday loan, racking up a new fee. Those fees are steep: $15 to $20 per $100 borrowed, which if done two weeks in a row works out to about 400% interest annually. In fact, the loan terms are so abusive that payday loans are illegal in 17 states and Washington D.C. They can't be made to active-duty service members, either.

The punishing nature of the loans was made clear by other data in the report. While some borrowers stopped using payday loans in the first year, the people still using them in year two tended to take out bigger loans more often, showing that their debt problems were growing worse. And across both years, nearly half the borrowers failed to pay off the loan at least once, incurring substantially more fees and adding to their financial stress.

'Money Really Does Grow on Trees' -- for the Lenders

Unfortunately, the data in the report almost certainly significantly understate the problems inherent to payday loans for two reasons.
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First, the data were collected between 2006 and 2008, before we hit the worst of the Great Recession. How many more families have turned to these loans since then? Second, the data come from Oklahoma, which has relatively strict rules on payday loans -- the key word being "relatively." Less-regulated states are likely to have worse borrower experiences.

According to the industry trade group, some 19 million Americans use these loans each year. Many more are surely tempted: A full 72% of Americans say they would have at least some difficulty paying bills if they missed a paycheck, according to a 2010 survey.

And boy, does the industry make the loans sound great. For example, a website I found Googling "payday loans" boasts:
"Regardless of your past, if you are currently employed and have a bank account, we can help you when it matters most. Have some bills due and you are not getting paid until next week?? Avoid the high cost of bounced checks from your bank and get a quick and easy Cash advance or a Same Day Payday Loan. ... At [the website], Money really does grow on trees!!"
The trade group does have a point, however, about the abusiveness of certain other types of credit:
$100 payday advance with a $15 fee = 391% APR

$100 bounced check with $56 insufficient funds and merchant fees = 1,449% APR

$100 credit card balance with a $37 late fee = 965% APR

$100 utility bill with $46 late and reconnecting fees = 1,203% APR
That's why consumers should seriously consider opting out of the "overdraft protection" plans provided by their banks. The fees involved -- even if they're $35 instead of $56 -- are ludicrous, and kick in for any transaction, no matter how small. Credit card fees are ridiculous too, but for better or worse, debtors don't have to pay off the whole principal each month, which allows them to manage the cash flow problems caused by late fees better than they could with with payday loans, at least for awhile.

If you want to preserve your financial health, don't use payday loans -- period. And do whatever you can to avoid falling victim to the abusive credit charges of other types of lenders, too.
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