For some, payday loans are described as predatory. For others, it can be a necessity.
Over 12 million Americans use payday loans each year. You may have seen the stories of how some have landed some in a debt spiral and needed to take another loan to pay the first one or similar articles. Many of us have heard stories like these. We decided to dig deeper on payday loans to see whether they’re truly as horrible as some suggest.
You will find more payday loan stores than McDonald’s and Starbucks these days, which can say a lot. The demand is fairly clear, and many of the lenders out there are all too eager to “help” when you need money now.
What is a Payday Loan?
This is a small dollar amount loan, which is usually between $100 to $1,000 that becomes due by your next payday. The funds are typically available in your bank account by next business day, and an option even if you have bad credit.
Legal Divide of Payday Loans
Within 27 states payday loans are found to be legal, and while 9 other states allow them, they have strict restrictions. Of the 14 remaining states there are laws surrounding payday loans that strictly prohibit them.
It’s the Consumer Financial Protection Bureau (CFPB) that regulates payday lenders. There are some cases where lenders use the sovereign status of Native American reservations to form partnerships and evade state law.
There are also some states that have laws about the number of loans a borrower may take at a single time. These require lenders to check a customer’s eligibility in real time databases to ensure the borrower is under the limit before they are allowed to issue a payday loan. There are also several states that have a limit for the number of times a borrower is permitted to take out a payday loan each year.
The CFPB website is a resource with answers to many questions related to payday loans.
The Payday Loans Debt Spiral
Not everyone all are great with money, and there are some lenders that try to take advantage of these people. Sometimes there are some lenders that will try push a customer into taking another payday loan, just to repay the first one. This is known as a rollover, and for some it can become the beginning of a debt spiral that can take months to break free.
In one study, it was found that payday loans by one lender were structured to create a sort of debt trap that drains bank accounts and causes significant financial harm, including delinquency, further overdraft fees, along with difficulty paying for such things like rent/mortgage and other bills. The less scrupulous lenders have been known to repeatedly flip the borrowers from one unaffordable loan to the next.
But there is a silver lining. At least for those with bad credit that can mostly manage their personal finances and have options available for where they might turn when they are in need of quick cash, even if it comes at a cost.
Unfortunately, there are a lot of people that don’t manage their finances well, and when they get behind on bills, some decide to take a payday loan.
This can be the beginning of their troubles.
If someone had a take home pay of about 2000 dollars, and most of it was to go towards bills, rent and essentials, if they take a payday loan of a thousand dollars it isn’t likely they would be able to afford to repaying the loan. This often becomes the beginning of a debt cycle for some.
There are many other times where a lender recognizes that someone borrowing over 25% of their typical income could be a problem for repayment, and limits the amount borrowed. But even when they probably know they won’t be able to repay, often the applicant will go to multiple other lenders so they can get the amount they’re after, even when it’s clear that they won’t be able to afford making their payments.
Within the United States, almost 10% of the population have what would be considered bad credit, or even no credit rating at all.
This means the bank won’t usually touch them, and their options are limited when they need cash.
A small dollar unsecured loans is not usually something the banks provide. Although recently it’s become available by one bank, but only to select individuals that have been customers for at least a year, which is not exactly a solution that all can use.
Ultimately, if you understand the rates and terms, there is an argument to be made for payday loans. If you have another option, it will often be best to go with that. But when your choices are limited, so long as you borrow responsibly, it can still work. Often it is the ones with poor money management or personal finance skills that become the “victim” which is often as a result of their own doing.
Are Payday Loans A Good Idea?
It depends on who you ask.
If you have bad credit and don’t have options, then possibly yes.
Also, it can take a week for a personal loan request from a bank, if you can get approved, and if you need the money immediately for a car repair or something else, the wait can be too much at times.
The annual interest rate (APR) of payday loans can be a shock. The national average annual percentage rate of payday loans is almost 400 percent. But since these are meant to be paid back by your next payday, the annual rate is not really applicable.
If you knew that your bank account was going to be charged soon and you prefer to avoid an NSF fee, taking a payday loan could help cover the amount for a couple days and make more sense than dealing with any non-sufficient funds fees, which can also affect your credit rating.
Part of the reason that payday loan fees can be so high is that many simply don’t repay the loan. In many cases, depending on the lender, this can be over 25% of the customers. Since the majority of payday loan customers don’t have a good credit rating, or any at all, many lenders won’t look at this and make their decision about what kind of risk the borrow might be based on their employment and other factors.