With the holidays approaching, people of every income range will be buying gifts for others. For many, this is just an added year-end expense. Others who feel the pressure to give to family and friends but don’t have the money may look for other ways to fund this seasonal expense. The ads for “payday” loans tend to prey upon that need, offering quick cash now with a short-term temporary loan. But before giving into temptation, be aware of the pitfalls that could affect your financial future into next year…and beyond.
What is a payday loan?
Also known as a cash advance or a check loan, a payday loan was originally given that name because repayment of the loan was typically due on the borrower’s next payday.
Some common features of payday loans include:
- the loan is for a small amount, generally $500 or less;
- repayment is usually due on the borrower’s next payday;
- the date of your next payday is disclosed to the lender to allow the lender to draft a payment from your checking account when the payment is due; and
- the loan has unusually high interest rates.
Generally, the loan can be used for whatever purpose it is needed: the necessary, such as an emergency medical bill or an overdue electricity payment, or the frivolous, such as a quick weekend trip. But the key to using the loan in the most advantageous way depends on when and how the loan is repaid.
The Trouble With Payday Loans
Regardless of when the loan is repaid, the interest rates charged by the lenders are exorbitant compared to other credit sources. Interest on credit cards typically ranges from 12 percent to 30 percent on an annualized basis. A payday loan, on the other hand, generally carries a finance of charge of $10 to $30 of every $100 loaned. The annual percentage rate (APR) on a charge of $15 per $100 rate would be about 400 percent.
The interest rate alone is bad, but the real problems begin when the loan is not repaid within the two-week period. Obviously, most people who turn to a payday loan for a critical expense one week are unlikely to be in a greatly improved financial position in two weeks. In many cases, the borrower has to rollover the loan to the next payday (or the next, or the next…) and the high interest rates continue to accrue.
Payday Lending Online
That’s an ugly picture, but it can get worse. Payday lending is illegal in many states, but lenders will often operate online in order to get at consumers across state lines. Beware the online payday lender – many of them are just scams. They’ll collect an upfront fee and leave you with nothing. The website (and your fee) will disappear into the night and you’ll be left with less cash than before.
Who uses payday loans?
When considering the “typical” payday loan borrower, the obvious answer is someone in at least short-term financial trouble. But a study done by Pew Research in 2012 provides more specific information: most payday loan borrowers are white women between the ages of 25-44. In addition, the study identified five groups that are more likely to take out a payday loan:
- those without a four-year degree;
- those who rent, rather than own, a home;
- those who earn less than $40,000 per year; and
- those who are separated or divorced.
Payday Lending Under Pressure
Many states have outlawed payday loans, having found them to be predatory and taking advantage of the people who use them. On the other hand, the lenders may choose to not do business in states that do allow them because those states have tightened their regulations on payday lenders to the extent that the lenders no longer make enough of a profit in those states due to the restrictions on interest rates and fees.
In 2013, the Consumer Finance Protection Bureau launched an aggressive investigation into payday lenders and their effect on American finances, soliciting complaints from consumers about their experiences with the loans. A year later, the Bureau has investigated almost 1600 of these complaints. Of those investigations that have been closed, only about 11 percent have resulted in a favorable outcome for the borrower.
During its investigation, the CFPB found that about 12 million Americans use some form of these loans. But the most disturbing part of the investigation was the discovery that almost 4 out of every 5 of the loans are not repaid within 14 days, causing the continuing high-interest renewal or rollover. And over 60 percent of those borrowers roll the loan over so many times that the interest and other fees end up being more than the original loan amount.
One consumer group, the Consumer Federation of America, states that the fault with the system is that the lender focuses on the ability to collect, not necessarily the borrower’s ability to repay. With access to the borrower’s checking account or employer information, the lender is in a position to collect the money owed if necessary. But why do that when more money can be accrued by just continuing to rollover the debt and increase the interest owed over and above what was originally loaned.
Another consumer group, Consumers Union, is looking for changes to be made and enforced in the industry. Among its recommendations are:
- limit the fees and interest that can be charged on the loans;
- make repayment schedules longer, e.g., a few months rather than a couple of weeks; and
- put a cap on the number of payday loans one person can borrow in one year.
Payday Loans in Bankruptcy
For those whose financial picture doesn’t improve enough to stop the continual rollovers and renewals, bankruptcy may eventually be an option to consider. If taking out payday loans is all that keeps a budget afloat, it may be time to look at putting a stop to the revolving door.
While payday loans in general may be discharged in bankruptcy, there are situations where the lender may have a valid objection. First, some debts incurred within 70 to 90 days of filing bankruptcy cannot be discharged because the creditor may claim that the debt was incurred while planning to file bankruptcy and discharge the loan with no intention of ever paying it back.
What to Do
If you’re struggling with your bills, exhaust all your other options before turning to payday lending. It’s likely to suck you deeper into the debt trap than ever. If you do decide to go the payday lending route, do everything you can to ensure that you can repay the loan in full and on time.
When debt gets overwhelming, it’s difficult to know where to turn. Reach out to a local bankruptcy attorney to discuss your options for dealing with your debt. They’ll sit down with you in a free consultation to talk about your situation and your options. Remember, talking to a bankruptcy attorney doesn’t necessarily mean you’re going to file for bankruptcy. They can also help you work through debt settlement or consolidation to ease the debt burden. They’ll work with you to determine the best solution for your particular situation.
Erik Clark is one of the leading bankruptcy attorneys in Southern California who has had the privilege of representing thousands of clients in chapter 7 and chapter 13 bankruptcy cases in the Los Angeles area. Erik has served as the past President of the National Consumer Bankruptcy Litigation Center (NCBLC) and the American Consumer Bankruptcy College (ACBC). His firm, Borowitz & Clark, is committed to using bankruptcy law as a tool for social justice and was one of the first consumer law firms to join the Law Firm Antiracism Alliance.