Payday loans don’t exactly have a great reputation. They are already illegal in about a dozen states, and unpopular in even more. In fact, there is plenty of payday loan legislation in the works every year. One failed bill from Mississippi last year even proposed declaring the site or location of a place of business where payday lending takes place as a public nuisance!
To Payday or not to Payday
For a business that’s only been around since about the early ‘90s, payday loans have flourished. In 2008 it was a $46 billion dollar business with 22,000 storefronts—meaning there were more payday loan storefronts than McDonald’s restaurants in the U.S. that year. Thanks to an economy still reeling from the recession, the payday loan industry has only grown since then—as has its reputation for targeting low-income communities.
Payday loans are generally fast, high-cost loans, usually for $500 or less. These loans, plus their often excessively high interest and fees, are paid back in a lump sum on the borrower’s next payday. This means the average term of a payday loan is about two to four weeks. When a borrower takes out a payday loan, they will be required to either write a post-dated check or authorize the lender to automatically remove the funds from your account on your agreed-upon date. If you don’t happen to have the money in your account that day, you could be facing some hefty fees. Still, 12 million people use payday loans every year, spending a collective $9 billion on lending fees.
Payday loans come with high interests
Many payday loans have notoriously high-interest rates. The national average is about 400%, meaning that some are much, much higher. This often depends on the state you’ll be taking out the loan in and whether they have caps on the fees and the cost of the loan. According to a study in 2016 by Pew Charitable Trusts, the average payday borrower is in debt five months of the year, spending $520 to repeatedly borrow $375 (the average loan amount). Paying off the average payday loan takes 36 percent of the average borrower’s paycheck, which not everyone can afford. That’s why many payday loan users renew or re-borrow the loans. Sometimes called “rollover,” this can add even more interest to what was once a small borrowed amount. In addition, the CFPB found that 80 percent of payday loans are taken out within two weeks of repayment of a previous payday loan. This puts repeat payday loan users in debt for much of the year.
There are some protections out there, thanks to attempts at regulation by the Consumer Financial Protection Bureau. The Military Lending Act (MLA), passed in 2006, puts a 36 percent cap on the interest rate for active military personnel and eliminates any prepayment penalties, among other protections. The CFPB proposed many other changes in 2016, in an effort to break the cycle of debt many payday loans force borrowers into. These include limiting the number of times lenders can attempt to debit the money from your account (resulting in a multitude of overdraft fees) and requiring lenders to take steps to determine if prospective borrowers would be able to pay off their loans in addition to basic living expenses.
Payday loans and poor credit
Most payday lenders would probably argue they are doing a service for the community by offering micro-loans to people in need who ordinarily couldn’t get loans. They often pitch themselves as great alternatives to paying overdraft fees if your bank account is depleted before payday. Of course, if your account doesn’t have enough money in it when they go to cash the post-dated check you gave them, you’ll still be paying overdraft fees.
Payday loans can also seem appealing to people with poor credit since many payday lenders don’t even run credit checks. The problem is, payday loans can still hurt your credit. If you can’t make the payment, they could turn to a collections agency, which could, in turn, inform the credit bureaus, thus impacting your credit. Or if your post-dated check bounces and you can’t pay it back, your bank could close your account and send it to a collections agency. Even if you do manage to pay back the payday loan in the 14 days or so you are given, that might require you to miss payments on existing debts—which, again, could negatively impact your credit. And even if you are one of the rare borrowers who can pay back a payday loan in full, on time, every time, it won’t help your credit. Since most payday lenders don’t report to the main credit bureaus, they won’t tell them what a great job you’ve done making payments. Instead, try credit-building installment loans or credit cards if boosting your credit score is one of your goals. If you’re going to take out a loan, it may as well benefit you to show how well you can pay it back!
Alternatives to a payday loan
So: should you take out a payday loan? Only if you have no other choice. Payday loan alternatives could include credit-building installment loans, credit cards, or debt management strategies.
With installment loans, borrowers are often able to secure a larger principal, or loan amount, which is paid off in a series of installments over a longer period of time. A standard unsecured installment loan could be for $2000 repaid over a 12-month term, for example. The benefit of these loans is that the smaller monthly payments are more manageable than scrambling to pay back hundreds of dollars within two weeks. Plus, many providers of installment loans communicate with credit bureaus. A history of making small, routine payments can actually help raise your credit score, making you eligible for a better loan with a better interest rate in the future!
When it comes to debt management strategies, options abound. You can talk to a consumer credit counseling agency, look into a loan for debt consolidation, or try to build a better budget and stick to it. Many financial resources recommend establishing an emergency savings fund. While that might seem a luxury, saving up for one now could help you avoid turning to an expensive payday lender in the future. Really, anything is worth trying if it means you don’t have to apply for a payday loan and risk entering an endless circle of debt.