With all the bad press payday loans get, including legislation aimed at curtailing the industry's predatory lending practices, you'd think people would steer clear of their local payday loan store.
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But that's just not the case. In fact, there are more payday lending storefronts (20,600 according to Community Financial Services Association of America) in the U.S. than there are McDonald's fast-food restaurants (12,804 according to NationMaster.com). The sign in the window might advertise "cash advance loans," "post-dated check loans" or "deferred deposit check loans." It doesn't matter -- they all work the same.
Why is the industry still thriving? Two words: fast cash.
"A payday loan can be approved within a matter of hours and there is typically no credit check," says Theodore W. Connolly, author of the "The Road Out of Debt." "Usually, you write a personal check payable to the payday lender for the amount you wish to borrow plus a fee. The check is dated for your next payday or another agreeable date within the next couple of weeks when you figure you'll be able to repay the loan."
When you get paid, the lender gets his money. That's the plan, anyway.
What can go wrong? For many people, a lot. Connolly, as counsel at the Boston law practice of Looney & Grossman, had an elderly client who had recently lost her husband. She borrowed based on her paycheck as a concession person at a movie theater. "By the time she came to me, her $250 loan was over $1,000 and the lender was relentless, even though she now only had Social Security as her income and was judgment proof," says Connolly.
Consumer groups have been pushing for limits on fees and interest rates, databases to prevent payday loan rollovers and other measures. In 13 states, payday lending is illegal or made not feasible by state laws. Twenty-one states have pending legislation in the 2012 session to date regarding payday loans, according to the National Conference of State Legislation. The federal Consumer Financial Protection Bureau, with broad power to regulate 'nonbank' financial entities, is also expected to increase regulations of payday lending stores.
You don't need to wait for legislators to help you stay out of trouble with payday lenders, however. All you have to do is read the fine print, calculate the real cost of getting stuck in a payday lending cycle and find some other way to get by until next payday.
Here are six ways payday loans can make you wish you'd found some other way to raise money or wait until you get paid:
1. Payday loans are incredibly expensive. Your most expensive credit card may have an interest rate of 28% or 36% -- tops. How does an interest rate more than 10 times that high sound? If a $100 payday loan costs you $15 for 10 days, that's an annual percentage rate of almost 400%. Payday lenders are most prevalent in neighborhoods where a significant number of residents cannot qualify for mainstream loans. It's easy money, but Connolly cautions, "accepting money with no credit check has its price, and it's called interest."
2. You can get stuck in a repeat cycle. Some of the more reputable short-term lending operations try to prevent this by maintaining a database of customers to help prevent rollovers, according to Stephen Altobelli, who represents Financial Services of America. "There are good payday loan operators and bad operators," he says.
Nonetheless, according to Center for Responsible Lending research, 76% of payday loans are to pay off old payday loans. The nonprofit consumer group also reported that even though most payday loans are to be paid within two weeks, on average the borrower stays in debt for more than half a year.
"When the day arrives that you have to pay the loan, you usually have two options: pay off the loan or pay a fee and roll over the loan for another two weeks," says Connolly.
3. Debt grows fast at these rates. "You will most likely end up paying three, four or even 10 times the amount you originally borrowed. Debt created by payday loans will often quadruple in just one year," says Connolly. "One tiny mistake can mean lifelong debt."
4. Payday loans are too easy. It takes time to apply for most other loans or credit cards. You can get a payday loan on your lunch hour -- giving you little time to think it over or consider other solutions, including not spending the money at all.
Payday loans carry no right of recession, either. That means if you change your mind shortly after you sign the papers or if your spouse convinces you to call it off, that's too bad. You can't back out.
5. Many payday loan companies require access to your bank account. As a "customer service," they say they will take the money right out of your account. You don't even have to write them a check! Good luck trying to get that stopped, however, when the balance has grown and you can't afford to pay it back and still afford your basic living expenses. If they just keep trying to shove their payment through, you'll get overdraft fees from your bank, too.
6. The day of reckoning, when you owe more than you can repay, can be unpleasant. Some payday loan companies have a reputation for horrendous debt collection practices. The Fair Debt Collection Practices Act should protect you from late night calls, threats of criminal prosecution, harassing you or your neighbors in person and other egregious violations of your rights.
Remember, however, that payday loan companies deal mostly with people who can't get loans through mainstream channels. According to Kristen Hagopian, radio talk show host and author of "Brilliant Frugal Living," payday loans also carry substantial risk to the lender with a default rate of 10% to 20%. These lenders are used to dealing very, very aggressively when people don't pay loans back as they promised.
If you write a check to be deposited later, and you don't have enough funds to cover it when it gets to the bank, both your bank and your payday lender will probably charge you bounced check fees.
Connolly's client was fortunate. Connolly was able to convince the lenders that she had no money or property they could attach. They held off on their threatened lawsuit, she moved to Pennsylvania, and as far as Connolly knows, she has not heard from them again. Not every case is resolved as easily.
"Given the high risk environment, not to mention the higher interest rates, it's obviously preferred for a household to avoid these loans like the plague," says Hagopian. "Do whatever possible to put a small amount of cash aside on a regular basis so as to avoid regular usage of payday loans. Using payday loans on a regular basis -- and paying them off with high interest come the following payday -- is basically throwing good money away."