Payday loans offer fast cash at a high price
The basics of payday lending
- Payday loans are small-balance loans that typically come due within a couple of weeks.
- Payday loans carry high effective interest rates that are usually reflected in fees.
- If payday loans aren’t paid off in time, the borrower faces stiff late penalties and bounced-check charges.
- A payday loan should be a borrower’s last resort after considering all other options for short-term cash.
People who need cash fast — and don’t mind paying a premium for it – can often get a payday loan.
A payday loan is usually an unsecured, small-balance loan under $500. It is called a payday loan because it is typically structured to be paid off based on the person’s paycheck schedule. Another type of payday loan can be secured by collateral, typically the borrower’s auto title.
In states where these high-interest loans are allowed (several states still forbid them), a person can go to a retail payday lender, fill out a post-dated personal check to secure the loan, and walk out with the cash.
More payday loans these days are being completed entirely online, however. The loans typically become due, or mature, within a few weeks. The person must pay-off the loan by the maturity date, or the payday lender will attempt to cash the post-dated check.
The future of payday loans in the U.S. is uncertain, as the federal Consumer Financial Protection Bureau (CFPB), in October 2017, announced new regulations designed to make it more difficult for people to get payday loans if they can't pay the loans back whiel still meeting basic living expenses. The regulations, which go into effect in mid-2019, limit the number of payday loans borrowers can take out in quick succession to three. Republicans generally oppose the regulations, and the republican-led Congress has 60 days to nullify them.
Profile of a payday lender
Payday loans are often used by people who don’t have access to credit cards. The borrowers tend to have annual incomes of less than $50,000 annually, although some studies suggest that the average borrower’s annual income is less than $30,000.
Studies also suggest that certain minority groups and young people are more likely to get payday loans. It is risky to attempt to stereotype borrowers, however, as the studies offer widely varying profiles of the typical borrower.
More clear is that payday lending has become a multibillion industry and is highly controversial. Consumer-advocacy groups and agencies, such as the CFPB, warn consumers about the traps involved with payday loans.
The CFPB also has fined several payday lenders for trampling on federal regulations, and the agency proposed new rules in June 2016 aimed at ensuring that borrowers are better able to pay back the loans and avoid getting trapped in a cycle of high-interest debt.
Payday loan traps
One of the biggest issues with payday lending is the high-interest charges, which are typically reflected in the form of a fee. A borrower may pay a $15 fee for a $100 loan on a two-week term, which equals a 391 percent APR, according to the CFPB.
Borrowers can especially run into problems when they can’t pay off the loan by the agreed-upon date. If that occurs, the borrower faces additional stiff fees from the payday lender, as well as potentially a bounced-check penalty from their bank — if the post-dated check provided to the payday lender to secure the loan is cashed and the account has insufficient funds. On the maturity date of the loan, the payday lender is often authorized to cash that post-dated check.
Borrowers also run the risk of falling into a perpetual debt cycle, repeatedly taking out payday loans to cover their debts and expenses for the month. This potential led consumer groups to call on federal regulators to set limits on payday-lending borrowing costs and also to limit the number of payday loans that can be issued to a borrower in a given year.
The bottom line is that payday loans carry serious risks and should be treated as a last-resort source of credit — to be tapped only when the borrower absolutely needs the money and has no other options.