So how bad are payday loans? What’s the Craic?

Exactly how bad are payday loans? Within the credit industry, no one is more reviled than the payday loan companies. They are notorious for high interest rates and for beckoning some consumers into a self-destructive cycle of debt from which they will never recover. Some good news is that there is regulation in the industry that has resulted in firm action being taken against unfair practies. If you ever wondered what happened to the Cash Store, one particularly unethical payday loan company, their license was taken away after their lending practices were deemed unethical. Hopefully, more regulation can help keep vulnerable people from falling into a debt spiral.

The payday lending companies say they merely provide a service that people need, and argue that while some people make bad choices there is still a legitimate market for the service they provide.

So really, how bad are payday loans? Below we examine this question in detail:

A Real Need for Fast Cash

One part of the payday lenders’ argument is true: people really do need money quickly due to a variety of circumstances (from health emergencies to surprise car breakdowns). However, the question is whether the terms of the transaction are reasonable.

Let’s dig deeper into the numbers to find our answer. According to the Consumer Federation of America, a consumer watchdog group, a typical payday loan company charges you $17.50 for each $100 you borrow. At first glance, that doesn’t seem egregious – after all, that equates to an interest rate of 17.5% which is lower than some credit cards.

But here’s the catch: the term is usually only two weeks. That means if you don’t pay the money back in 15 days, you get charged another 17.5%. Then, if you still haven’t paid off the loan after 30 days, you’ll be charged – you guessed it – another 17.5%.

So what happens if you’re not able to pay the loan back immediately?

You might quickly find yourself underneath a mountain of debt. Let’s say, as an example, you need to borrow $500 to pay for repairs on your car, so you get a payday loan. However, it turns out that it takes you four months to save enough money to pay back the loan. During that time, the loan rolls over 8 times, meaning you get charged 17.5% interest eight times on the original $500 loan. Here’s what your interest would look like:

$500 x 17.5% x 8 terms = $700

That represents a whopping 140% interest over the 8 terms! In terms of APR, this ends up equating to about 455%. Yowza! Compared to other forms of short-term borrowing, that is abominably high. Even a credit card with insanely high interest rates has an APR of no more than 40%. This chart (w/ data from the CFA) shows expected interest rates for four types of short-term loans:

 

Type of Credit	Finance Charge	APR	Total Paid
Small Loan	$38.04	36.00%	$538.04
Credit Card Cash Advance (Average)	$48.86	29.10%	$548.86
Credit Card Cash Advance (Higher Cost)	$66.77	39.28%	$566.77
Payday Loan	$700	455%	$1,200

 

As you can see, the payday loan dwarfs the other four types in total cost. Which is why we can pretty easily conclude that payday loans are predatory. So borrowing from payday loans is more than 10 times as bad for your finances as borrowing cash from your credit card company. A 455% interest rate over four months is unreasonable.

Things you might not know about payday loans:

• They usually range in size from $100 to $1,000
• The finance charge amount is often between $15-$30 per $100 borrowed
• To get a payday loan, a person generally needs an open bank account, a post-dated check, a steady source of income, and some form of identification.
• There are approximately 20,000 payday loan stores in the U.S.
• Those stores made around $4.7 billion in revenues in 2010
• Consumers with payday loans have an average of 8-13 payday loans per year
• Your credit score is in jeopardy if you fail to pay off the loan, because the lender will attempt to deposit the post-dated check and it will bounce. If that happens several times, your credit score will be ruined.
• Payday loan users are almost twice as likely to file for bankruptcy as borrowers who are turned down for a payday loan.

So if you’ve ever had the question ‘How bad are payday loans?’ pop into your head , now you know the answer: ‘they are very, very bad’

How to Protect Consumers

Many payday lenders use practices that push against the limit of the law – and some have been found to use blatantly illegal tactics. In some cases, these practices are starting to garner attention. Earlier this week, CBS News reported that the Attorney General of Arkansas is suing payday lenders who were not following the law:

Arkansas Attorney General Dustin McDaniel has sued a Missouri man and two companies that control Internet payday loan websites which offer loans to consumers at interest rates exceeding 600 percent.

At the federal level, the new Director of the Consumer Financial Protection Bureau (CFPB) has vowed to focus on rooting out illegal practices within this industry. He said, “it’s important that these products actually help consumers and not harm them. We know that some payday lenders are engaged in practices that present immediate risks to consumers and are illegal. Where we find these practices, we will take immediate steps to eliminate them.”

That’s the kind of purposeful leadership we need to protect consumers from falling into the destructive cycle of debt that is such a risk when dealing with interest rates that go beyond 455%.

What can you do?

If you have any experience with predatory payday lending practices, the CFPB wants to hear from you. Click this link to share your story online, which can be done anonymously, so that they can understand the point of view of the consumers (that’s you!) and take steps to reform them.