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You can borrow money against your next paycheck using payday loans and app-based cash advance services to meet your immediate financial needs. However, these services might be detrimental rather than beneficial due to their high borrowing costs.
Payday loan APRs frequently exceed three figures and, in some cases, even four figures due to a patchwork of state-level regulations that govern annual percentage rates for short-term payday loans. Comparatively, the APR on credit cards is 15 so far in 2020. 09%, according to the Federal Reserve.
Traditional payday loan usage has decreased in recent years, but a new generation of app-based cash-advance lenders is filling the gap. Consumer advocates are concerned that as incomes decline due to the COVID-19 pandemic, more people may turn to predatory financial services.
According to Lauren Saunders, associate director of the National Consumer Law Center, a nonprofit consumer advocacy group, “People turn to them because they don’t have enough money.” However, she claims that if you work fewer hours, neither an advance nor a loan will provide you with additional funds. “It just makes next week worse. The COVID situation really highlights the weaknesses of these programs. ”.
Despite the dangers, some consumers believe they are their only choice in difficult financial circumstances. Here are all the things to think about before applying for a payday loan or using a cash advance app, as well as funding options and money management tips to help you steer clear of both.
Cash Advance vs. Payday Loan
Consumers see more similarities than differences between payday loans and cash advance services. Both services offer the chance to borrow money that you can repay from your next paycheck, promising quick cash when you need it.
Saunders claims that pricing makes the biggest difference, noting that payday loans are infamous for having high annual percentage rates. However, one shouldn’t ignore the fees and gratuities that are frequently requested in exchange for earned-wage services, also referred to as “tips.”
Traditional payday loans in the United States have a lengthy and contentious history. S. Legislators have tightened and loosened restrictions on lenders over time by passing laws that outline the maximum financing costs and permitted loan term lengths. Payday loans are still permitted in the majority of states, despite regulatory efforts to restrict them. And some states have no explicit interest caps at all.
App-based cash advance services, however, are a relatively new concept. These services, which are frequently offered by fintech startups rather than conventional payday lenders, are also known as earned-wage, early-wage, or payroll advances. The majority of significant providers, such as Earnin, PayActiv, and Dave, have emerged in the previous ten years.
Earned-wage advance services like Earnin and Dave ask users to tip on their “free” cash advance rather than charging loan financing fees. Dave suggests a tip between 5% and 15% of the total advance, while Earnin suggests tipping in dollar amounts up to $14 per advance. PayActiv advertises itself as a payroll benefit to employers and earns money from membership and service fees.
Payday services appeal to the most economically vulnerable populations. More than 8.9 million American households used alternative financial services, including payday loans, in the past 12 months—and they’re disproportionately lower-income earners, according to the most recent survey data available from the Federal Deposit Insurance Corporation (FDIC).
According to consumer advocacy organizations, people use payday loans and payroll advances for the same reason: They don’t have enough money right now and require assistance to get by for the next few weeks. Consumer advocates often describe the advances or loans as starting a dangerous “debt trap” or “cycle of debt” rather than being helpful. ”.
“You’re very likely to have a hole in your next paycheck if you run out of money and borrow against it,” warns Saunders. It will be difficult to avoid borrowing money again during the following pay period as a result of that. ”.
Payday loans as well as earned wage advances may have that spiraling effect.
What to Know About Payday Loans
According to nationwide data compiled by the Consumer Federation of America, 31 states allow payday lending. The remaining 19 states and Washington, D.C. have regulations that either explicitly or effectively prohibit payday loans in the traditional sense—as a two-week, high-interest loan.
However, there are no interest rate caps in four states, and Missouri permits a 1,950% APR for a $100, 14-day loan.
It’s all in the math as to how a payday loan’s APR can be so high. APR looks beyond simple percentages and factors in time. For instance, a Missouri consumer may be short on cash and require a loan for two weeks to help them get by. When payday arrives, the lender will deduct a $75 fee from the $100 they withdraw now. The interest rate might initially appear to be 75%. That’s because time isn’t factored in.
Annual percentage rates should be used to calculate the true cost of payday loans. Because the loan term is so brief, a seemingly low borrowing fee could cause the APR to skyrocket.
Consumers in need of quick cash are frequently targeted by advertisements for payday loans, which are typically simple to obtain in comparison to other financial services. In many cases, consumers can get approved with just an ID, income documentation, and a bank account. Lenders often skip over credit checks and approve applicants quickly.
Although the quick cash may seem like a solution, it often leads to a cycle of dependency. Consumer advocates advise against using them altogether or only as a last resort.
Payday loan and predatory debt researcher Charla Rios of the Center for Responsible Lending wrote in an email that research has repeatedly demonstrated that the product has more negative effects than positive ones.
Though for many consumers, that’s common knowledge. As a result, they’re turning to fintech alternatives.
What to Know About Cash Advance Apps and Services
According to consumer advocates, the two most well-known cash advance apps, Earnin and Dave, position themselves as better options than predatory payday lenders.
According to Rios, “They are currently using marketing to appeal to consumers and potential borrowers as the friendly neighborhood figure.”
Earnin, for example, offers advances between $100 and $500. Users must submit a lot more personal data than they would for a payday loan in order to be approved for an advance. Users of the app must grant Earnin access to their bank accounts so that it can examine payment history and other factors.
The app monitors user GPS data throughout the duration of an approved advance to make sure a borrower is actually traveling to their place of employment. The advance amount is then automatically subtracted by Earnin once payday arrives and the direct deposit stops. No interest. No fees.
Earnin therefore receives voluntary tips, ranging from 0 to 14 dollars per advance. But the phrase “voluntary tips” could confuse consumers.
For instance, the term “tipping” may make you think of gratuities and other manners related to the service industry rather than predatory APRs. Tipping on a cash advance is very different from tipping your Postmate for a prompt delivery.
Saunders took aim at a different word: voluntary.
When referring to a practice that Earnin stopped using, Saunders says, “In the past, it hasn’t turned out to be so voluntary.”
According to a report by the New York Post, as recently as September 2019, Earnin would limit advance amounts to New York residents who didn’t tip. The Post reported that Earnin ditched the practice due to an ongoing investigation by the New York Department of Financial Services (NYDFS).
The NYDFS launched an investigation into Earnin and similar earned-wage lenders in March 2019 to determine whether they are infringing on small-loan rate caps. Ten states and Puerto Rico joined the investigation by August 2019.
The tip, according to detractors and investigators, might exceed limits on predatory lending and violate state laws.
“A $100 advance taken out five days before payday with a $5 fee or ‘tip’ is equivalent to an annual percentage rate of 365%,” the National Consumer Law Center wrote in a March report on earned-wage advances.
Despite any potential APR issues, Rios and Saunders caution that, like payday loans, payroll advances can cause a cycle of debt.
According to Rios, “accessing future earnings does not solve the initial cash shortage problem.”
Earnin chose not to respond when asked how frequently its users request advances or tip, or how tip rates compare to those of predatory loans.
How to Get Out Of Payday Loans
It can be difficult to escape the debt trap of payday loans, but it is possible. Consolidating payday loans with another low-interest debt instrument is one way to get rid of them.
To pay off the payday loans, for instance, you could apply for an installment loan. By doing this, you could lower your payment and save money on interest and fees by moving your debt from a payday lender to a personal loan lender. One affordable installment loan option for consolidation is the Payday Alternative Loans (PALs) provided by credit unions.
Asking the lender for an extended payment plan that spreads payments over several months is another choice for repaying payday loans. Since you won’t have to rush to pay off your debt within a pay period, extended plans can make payments simpler to manage.
If you’re in a bind, borrowing money from friends or family may be your last option. When you can’t pay, rolling over payday loans to new terms can be expensive. Using a peer loan could help you avoid accruing further fees. Just be certain that the terms of repayment are understood by both you and the person lending you the money.
How to Avoid Payday Loans and Cash Advance Loans
Financial crises are sometimes unavoidable, but how you react to them is under your control. The consensus is pretty clear: Avoid both payday loans and earned-wage advances, as either one could trigger a long-term debt cycle. The Consumer Financial Protection Bureau recommends several steps you should take before you borrow from your next paycheck.
Beyond that, Rios advises avoiding places that “promise quick cash or don’t look at any ability to repay loans.”
Saunders advises thinking about payroll advances or earned wages if you’ve run out of other options before taking out a payday loan. She claims that in a perfect world, the advance would be provided by businesses like PayActiv, which offer payroll services through your employer.
She advises considering the direct-to-consumer versions like Dave or Earnin only if you are confident that your upcoming pay period will be larger than usual. This prevents an income hole in your next paycheck.
It’s probably not a big deal to take an advance if you have a stimulus check coming in the next week and you know you will have extra money coming in. But that’s an unusual situation,” Saunders says.
She points out that although the new generation of fintech payroll lenders may seem innocent, they are “for-profit, moneymaking ventures” that aren’t giving the advances out of the goodness of their hearts.
Frequently Asked Questions (FAQs)
Your ability to obtain payday loans may vary depending on your state and lender. Some states have annual caps on the number of payday loans you can obtain. For instance, you are only permitted to obtain up to eight payday loans per year in Washington state.
To find out the rules that apply to you, check with your lender or state, but keep in mind that getting several payday loans can trap you in a cycle of debt. Even if you are able to take out several loans, limiting your payday loan borrowing can help you stay out of debt.
How do you find out if you have outstanding payday loans?
Your credit reports, which you can obtain for free at AnnualCreditReport, should be checked first for any outstanding payday loan debt. com. Payday lenders typically do not report payday loan accounts to credit bureaus, but collection accounts with unpaid loan balances may do so. To find unpaid debt for loans that might not be appearing on your reports, it’s a good idea to get in touch with the lenders you borrowed from.
How do you pay off multiple payday loans?
You can save money on fees and make your payments more manageable by consolidating your payday loan debt with an installment loan. In addition to debt consolidation, if you have extra money, you could pay off your payday loans sooner by requesting an extended payment plan or making extra payments.
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Former assistant editor at Forbes Advisor, Adam Hardy covered technology and small business. He previously worked as a staff writer at The Penny Hoarder, where he specialized in entrepreneurship and the gig economy. His work has appeared in publications such as Yahoo! Finance, the Asia Times, Business Insider, Creative Loafing, the Tampa Bay Times, and others. The Forbes Advisor editorial team is independent and objective. We receive money from the businesses that advertise on the Forbes Advisor website to help fund our reporting efforts and to keep providing this content without charge to our readers. This compensation comes from two main sources.
Does cash advance hurt your credit?
Your credit score won’t be negatively impacted by a credit card cash advance directly, but it will be impacted negatively in the long run because it will increase your credit utilization ratio and outstanding balance.
What are 3 alternatives to getting a payday loan?
- Local nonprofits and charities.
- Medical bill assistance.
- Bad-credit online loans.
- Credit union loans.
- Payment plans for monthly expenses.
- Other ways to make money.
- Lending circles.
- Family loans.
What are cash advance loans?
A short-term loan is a payday loan or cash advance. Even if you only borrow the money for a few days or a week, you must pay a fee. It may be very expensive to take out a payday loan or cash advance. Think about other borrowing options before applying for one of these loans.
How does payday cash advance work?
Payday loans are short-term loans, typically for two weeks. You can get cash the same day by writing a postdated check or by providing a debit card number. When the check’s due date arrives, the lender will cash it to settle the loan in full.