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Five Reasons to Avoid Payday Loans

Posted December 28th, 2011
by Site Administrator (no comments)

There is no denying that in an emergency situation – when the electricity is about to be shut off or a car tire blows out – short-term payday loans can seem like an attractive solution if funds are tight. Borrowers only need a pay stub, proof of identity and a bank account to gain instant access to cash without a credit check.

Despite the seemingly obvious benefits, payday loans have repeatedly proven to be an incredible financial drain on people who already live paycheck to paycheck. Often referred to as predatory lenders, these companies tend to cater to those who rely on a limited budget. Before signing the loan agreement, consider these five reasons to stay away from payday loans.

  1. Excessive Interest
    Payday loans are typically issued for no more than half your take-home paycheck. Most loans are $100 to $500 and are issued for seven to 30 days. Although some states have capped interest rates at 36 percent, payday lenders are allowed to charge any rate they want. Loans typically start at 300 percent but can go as high as 1,000 percent. Even at the low end of the spectrum, a two-week, $300 loan will cost nearly $35 in fees.
  2. Cycle of Debt
    Before leaving the store, you must provide a post-dated check that covers the loan and the fee. Online payday loan companies require a debit card so funds can be automatically withdrawn from a bank account. Fees may be just high enough to cut into living expenses for the following pay period, which means the loan needs to be renewed.
    If you cannot pay the agreed upon amount by the due date, you can pop into the store before the check is cashed to extend the loan by only paying the interest. Oftentimes, a $30 verses a $335 payment is more affordable. Within five months, the interest charged on the account will equal the original $300 principle loan. Despite making monthly payments, no progress is made on paying off the actual debt.
    The Center for Responsible Learning (CRL) describes the short-term aspect of payday loans as a myth. A CRL study that followed 11,000 borrowers for 24 months found that many continued to carry a portion of the original debt two years later. “The actual experience of payday loan borrowers reveals there is nothing quick about the loan except its small principal,” the report criticizes.
  3. Damages Credit Score
    Many people believe that any type of loan will help boost their credit score, which determines the interest rates charged on all loans, the premiums paid for car insurance policies and the homes that people are able to rent. When reviewing credit reports, lenders see payday loans as a sign that you are already struggling to pay the bills.
  4. Too Easy to Default
    The CRL study on payday loans found that 44 percent of borrowers defaulted on their loans. Payday lenders require a postdated check to cover the original loan agreement. If the check bounces when the lender deposits it, the account goes into default, which triggers a higher interest rate. The account is also assessed a Non-Sufficient Funds (NSF) fee, as well as a late fee. The company may submit the check multiple times in an effort to collect their cash, which means your bank account racks up numerous fees. For each additional month the account is delinquent, the charges increase, up to a cutoff amount of 520 percent of the original loan.
  5. The Industry is Largely Unregulated
    The Federal Trade Commission (FTC), which until recently served as the governing body of the payday loan industry, has determined that all lenders have the right to set their own fees and interest rates. Payday lenders make most of their money on default loans, which are charged fees for being late, extending due dates, collections and insufficient funds. The new Consumer Financial Protection Bureau (CFPB), created by President Barack Obama, will now oversee industry regulations.

In the absence of federal guidelines, several states have enacted strict payday loan regulations that cap annual interest rates and limit the number of storefront locations in low-income neighborhoods. Federal laws do prohibit payday lenders from charging more than 36 percent interest to members of the military.

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