Want to guess at a community’s financial health? Abandoned houses or vacant shopping centers are an obvious sign things aren’t good, but a more subtle indication of financial insecurity is the number of payday lenders in the area — businesses that cater to cash-strapped customers willing to pay exorbitant interest for small personal loans.
According to a 2015 study by the Pew Charitable Trusts, 12 million Americans take out payday loans each year and spend $7 billion on loan fees. Though the interest rates commonly are disguised as fees, they effectively range from 300%-500% annual percentage rate (APR).
Compare that the 15%-30% APR on credit cards or 10%-25% rate for a personal loan from a bank or credit union and it’s hard to see why anyone would go this route.
According to Pew, the typical payday loan customers are mainstream workers, those earning at least $30,000 a year. Payday lenders target financially strapped customers who don’t qualify for credit cards or have very low credit limits, mostly due to past financial problems. While people with conventional credit cards can use their borrowing capacity to cover short-term needs, those without credit often have nowhere to turn. They might use a payday loan to cover rent and avoid eviction or utility bill to avoid cut off, but the huge interest payments usually leave them in worse shape.
Payday loans allow consumers to borrow small amounts of money, usually $500 or less, to be repaid on their next payday. These short-term, high-interest loans are easy to qualify for but come with risks. Understanding the pros and cons of payday loans can help you make an informed decision if you’re considering one.
Pros of Payday Loans
Fewer Approval Requirements
Payday lenders typically only require that borrowers have a regular income and a bank account. They rarely check credit scores or require collateral. This makes them more accessible for people with bad credit or no credit history. When emergency expenses arise and poor credit limits other borrowing options, a payday loan may be one of few ways to get needed cash quickly.
Quick and Easy Process
The payday loan application process is simple and can usually be completed entirely online Lenders provide fast decisions, sometimes instantly approving qualified applicants Once approved, funds may be deposited directly into your bank account as soon as the next business day. The ease and speed of the process make payday loans helpful in financial emergencies.
Cons of Payday Loans
Steep Interest Rates and Fees
A major downside of payday loans is their high cost. Fees typically range from $10-$30 for every $100 borrowed. When annualized over a typical two-week loan term, this equates to triple-digit APRs. Rollover fees apply if the loan isn’t repaid in full by the due date. These add more costs each time the loan is extended. Interest and fees can rapidly multiply, making repayment difficult.
Risk of Debt Traps
Because of their high cost, payday loans can trap borrowers in cycles of debt. The typical payday loan takes up over one-third of a borrower’s next paycheck. This leaves little remaining to cover other expenses until the next pay period. Borrowers who can’t fully repay often take out a new loan, incurring more fees. Repeat borrowing accounts for over 80% of payday loan volume. It’s easy to end up deeper in debt each pay cycle.
No Credit Building Benefits
Payday loans don’t require a credit check and repayment isn’t reported to the credit bureaus. This means that responsible use of payday loans doesn’t help build your credit history. If you default on repayment, the delinquency can be reported and damage your credit score. Overall, payday loans provide no long-term credit building advantages.
Access to Bank Account Required
To be approved for a payday loan, you must provide the lender with access to your checking account. This allows them to withdraw the repayment, fees, and interest automatically when the loan comes due. However, if funds in your account are insufficient to cover the withdrawal, you can be charged expensive overdraft fees by your bank in addition to late fees from the lender.
Alternative Options Often Available
In many cases, there are safer and cheaper alternative borrowing options available even to borrowers with bad credit. Personal loans from online lenders may offer lower interest rates, flexible repayment terms, and the ability to build credit. Asking for an advance from your employer or borrowing from friends or family are also options to consider before turning to high-cost payday loans.
Weighing the Pros and Cons of Payday Loans
Payday loans provide quick access to cash for those in need but come with risks like high costs, repeat borrowing cycles, and bank account overdrafts Their ease of approval and funding makes them helpful in true financial emergencies with no other options available However, the downsides mean payday loans should only be used as a very last resort after all other alternatives have been exhausted. Carefully considering both the pros and cons can help ensure you make the right decision for your personal financial situation if considering a payday loan.
Banks Could Be Making Small Loans
In spring 2018, the federal Office of the Comptroller of the Currency, which regulates national banks, announced that banks would be able to write loans smaller than $5,000 and not be subject to standard underwriting rules. The goal is to expend bank lending to people whose credit makes it impossible to qualify for conventional loans or credit cards.
Banks used to make those sorts of loans, called deposit advances, which were generally repaid quickly – often before a borrower’s next paycheck. But new banking rules ended the practice in 2014 after regulators warned that deposit advances sometimes led borrowers to crippling debt. The 2018 revision will allow banks to return to the business, but perhaps not for long. The CFPB is scheduled to impose strict regulations on loans of 45 days or less.
However, in June of 2018, the bureau’s acting director said he would like to reevaluate that rule.
Who Uses Payday Loans?
According to the Community Financial Services Association of America, there are an estimated 18,600 payday advance locations nationwide that have extended $38.5 billion in credit to 19 million households.
The simplicity of borrowing and the easy access to cash make payday lending appealing to many consumers, mostly those who have little or no access to conventional credit.
Payday lenders rely on repeat customers, often low-income minorities, charging exorbitant compounding interest for cash advances. They seldom offer borrowers workable repayment plans, and in many states, operate with few regulations.
Payday lenders advertise on TV, radio, online and through the mail, targeting working people who can’t quite get by paycheck to paycheck. Though the loans are advertised as helpful for unexpected emergencies, seven out of 10 borrowers use them for regular, recurring expenses such as rent and utilities.
Payday lenders offer cash-advance loans, check-advance loans, post-dated check loans or deferred-deposit loans. They almost never check credit histories, making their loans easy to get, but interest rates are extremely high, and customers are among the nation’s least savvy borrowers.
The Consumer Financial Protection Bureau (CFPB), a federal government agency, issued a report in 2014 that showed most payday loans are made to borrowers who renew their loans so many times they end up paying more in fees than the amount they originally borrowed. The average payday loan borrower spends $520 in fees for what originally was a $375 loan.
Despite the well documented consumer hazards, the U.S. payday loan business thrives in states that don’t put caps on interest rates. In 2008, a Dartmouth economist said there were more payday loan outlets than McDonald’s restaurants and Starbuck’s coffee shops combined. But there are signs the business is in retreat as an increasing number of states have imposed rate caps. The Pew study said the number of states where payday loan lenders have operations, dropped from 44 in 2004 to 36 in 2015.
The decline in operations has cut deeply into the payday loan business. The nonprofit Center for Financial Services reported a steep decline in the storefront loan business that began in 2013, with revenue falling 23.4% from 2014 to 2015 alone. Revenue also fell by 22.5% for nonbank online payday loans in the same period.
But as payday loan revenue declines, issuers of subprime credit cards have made big gains, keeping the level of all subprime consumer lending relatively constant in the past several years.
Should You Get a Payday Loan? (Pros and Cons)
FAQ
What are the advantages and disadvantages of a payday loan?
Is payday loan a good idea?
What is risky about a payday loan?
Can payday loans hurt your credit?
Are payday loans a good idea?
Payday loans are often for small amounts of money, commonly $500 or less. They are designed for borrowers who are in a pinch — maybe you need cash to cover an unexpected medical bill or a damaged item. Payday loans provide immediate funds, come with extremely high interest rates, and are usually based on your income, not your credit history.
Are payday loans expensive?
While payday loans offer quick access to cash, these short-term loans carry high finance fees that make them expensive. Consider alternatives, like a payday alternative loan, credit card or personal loan, that can be more affordable. What Is a Payday Loan? Should You Avoid Getting a Payday Loan?
What is a payday loan & how does it work?
A payday loan is a short-term, small loan that you repay once you receive your next paycheck, typically two to four weeks after you take out the loan. Payday loans tend to have small loan limits, usually up to $500, and don’t require a credit check.
Are payday loans dangerous?
Payday loans can be dangerous, often due to high interest rates and fees. These loans often need to be repaid by your next payday, which can be challenging for many borrowers. The typical payday loan is $350 and comes with a $15 fee per $100 borrowed, according to the Consumer Financial Protection Bureau (CFPB).