NEW YORK (Main Street) – With flashing neon signs promising “same day money”, billboards displaying “everyone is approved” and seemingly endless “no credit check” pop-up ads, it seems that payday loans are unavoidable. And for many, they are.
According to The Pew Charitable Trusts12 million Americans use payday loans every year through 20,000 storefronts, hundreds of websites, and a growing number of banks that now offer payday loans to their customers.
And the cost is enormous. “Quick money always comes at a price,” says Cary Carbonaro, CFP board advisor and author of the The Money Queen’s Guide (Morgan James, 2015). For payday lenders it means high interestand since the term of the loan is usually fixed at two weeks, the interest skyrockets, accumulating at a terrifying rate.
“Financing fees are 15-30% of the amount borrowed,” says Jeff Motske, CFP, president of Trilogy Financial Services and author of The couple’s guide to financial compatibility (Da Capo Lifelong Books, 2015). “Since it’s 15-30% over a few weeks, it’s comparable to getting a loan with an overall effective rate close to 800%.”
To put it another way, Pew found that borrowers paid an average of $520 in interest on a small $375 payday loan.
The cycle begins
Due to the quick turnaround and high interest rates, many customers won’t be able to pay off the entire balance by their next payday. Lenders have a solution for this: extensions.
By paying more fees, customers can extend their loan over another pay period. But any money paid at the time of extension will be applied to interest, not principal, which means the total due will be keep growing.
This creates what Motske calls a “vicious cycle”. After studying more than 12 million storefront payday loans over a 12-month period, the Consumer Financial Protection Bureau found that only 15% of borrowers could afford to repay the loan on the first try. In the final stretch of their loan cycle, 80% of borrowers who took an extension owed the same or more than they originally owed. It is really hard to kill a payday loan.
Fool me once
In fairness, payday loan borrowers are not going blind. Federal law requires all lenders, even the sleazy ones that use pop-up ads and spam, to explain in writing in advance what a customer is getting into.
According to Carbonaro, payday loans fall under the Federal Truth in Lending Act, a law that requires all lenders to clearly define terms and disclose interest rates and fees up front. Consumers are also protected by state laws. “The cash advance industry is heavily regulated by state officials across the country,” she says. “State laws generally limit the principal amount of an advance, set maximum fees, limit a customer’s ability to renew an advance, and require various disclosures. »
You could argue (and many experts do) that payday borrowers should know not to fall into the debt trap created by high-interest payday loans. But are there better options for consumers with bad credit or limited income?
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Finding an alternative
When faced with a financial challenge, some consumers are locked out of banks, unable to qualify due to past credit issues or limited income. In the past, deprived of other more desirable options, such as borrowing funds from friends or family members, consumers turned to payday loans. Now many are turning to a new kind of fast money lender.
Often web-based, these lenders offer fast processing and turnaround times, and many are willing to work with borrowers who have bad credit or other extenuating circumstances. For example, Lending Club, a web-based company that provides loans through WebBank, offers personal loans up to $35,000 and claims to fund “within days.” Another company, Springleaf Financial, offers a variety of personal loans with customer testimonials claiming approvals come within hours.
The loan amounts and variety of payment schedules seem closer to personal loans through a traditional bank, but some tactics of this new breed of lenders seem awfully familiar. After all, promising “online approvals” and “quick cash” are typical of payday loan companies, but does that mean the new ones are just as predatory?
After analyzing the options available through our sample lenders, Carbonaro doesn’t think so, at least not entirely.
“From what I can tell, they’re a little better and a little less predatory,” she says, “Both are options for people with bad credit.”
Do your due diligence
This does not mean that these examples should be taken as a recommendation. Anyone considering a loan, even an alternative to a payday loan, should do some research. Many lenders don’t utter the word “payday,” but that doesn’t mean the business is legit.
After all, if he walks like a duck and quacks like a duck, he’s probably a duck (or in this case, a high-interest moneylender). Look for telltale signs like promises of instant application approvals, overnight funding, and paperless loans. Trust us, legitimate lenders will at least want to verify your employment.
If the lender passes the first test, ask about the company’s track record.
“Ask yourself, ‘How long has the company been in business?'” says Motske. “If they’ve only been in business for a few years, that could be a red flag. Have consumers filed complaints online and with the Better Business Bureau? Done [the lender] follow the best practices of the Community Financial Services Association of America? »
If the company still seems to be on the rise, be sure to read the full disclosures, no matter how much you resent the tiny font and endless legal terms. Some lenders will introduce some really terrible terms in these disclosures, and you should know what you’re getting up front.
And if you do sign up, be sure to do so with a way to repay the loan. The lender may be a cut above a payday store front, but with any loan comes the risk of a debt cycle.