Payday loans may seem like a quick fix for financial trouble, but they can come with hefty fees and rates. These can make them very expensive and can lead to a cycle of debt.
People who rely on payday loans tend to have lower incomes, and are more likely to be in poor health, such as with higher blood pressure or a larger body mass index. They may also be at greater risk of being targeted by debt collectors.
Exorbitant Interest Rates and Fees
While the quick access to cash that payday loans provide can be attractive in a financial pinch, these short-term loans come with exorbitant interest rates. In fact, the average two-week payday loan has a fee of $15 per $100 borrowed, which works out to an annual percentage rate of 391% (source: CFPB).
While states have laws in place regulating payday lenders and limiting their interest rates, these fees are often hidden and difficult for consumers to understand. To help shed light on this issue, researchers at the Center for Economic and Policy Research reviewed available state regulatory reports and advertised product options from the largest payday lender chains to estimate dollar costs for each type of loan in each state.
Payday loans are often structured as a “revolving debt” that requires borrowers to roll over the loan when it becomes due, rather than paying down principal. This allows the lender to collect additional fees and extend the term of the loan. In some cases, the revolving nature of these loans can result in borrowers paying more in fees than the amount they originally borrowed.
In addition to high annual rates of interest, borrowers can face other charges and penalties. For example, borrowers who take out online payday loans are more likely to incur bank penalties because of overdrafts or failed debit attempts. Half of borrowers who have at least one overdraft or failed debit attempt on a payday loan end up having their bank accounts closed involuntarily, according to a study by the CFPB.
Those with a history of payday borrowing also have higher body mass indexes and blood pressure, as well as a lower credit score than those who have never taken out a payday loan. And because of the disproportionate impact on low-income communities, payday lending has been linked to social inequalities in health outcomes across the nation.
If you find yourself in a cash emergency, there are many alternatives to payday loans that are less expensive and may offer better terms. Check out the offerings at your local credit union or community bank, for instance. And try to set aside a small emergency savings fund so you aren’t forced to borrow when unexpected expenses arise.
A Cycle of Debt
A debt cycle occurs when you borrow more than you can afford to pay back. It usually starts when you spend more than you earn, leading to credit card balances that become too large to manage without taking on more debt. It may also begin when an emergency expense strikes and you lack the savings or income to cover it, forcing you into a cycle of borrowing. Relying on payday loans can be particularly dangerous, as these short-term loans typically come with high interest rates and fees that can add up quickly.
Payday lenders target cash-strapped consumers looking for quick access to funds, typically because they lack the means to qualify for traditional banking loans. Their products offer easy credit with scant requirements, and many have locations in low-income communities where residents tend to be more vulnerable to the loan industry’s predatory practices. In addition, federal deregulation has made it easier for payday lenders to operate with fewer regulatory controls.
While the average payday loan lasts just five months, people who take out these loans pay more than twice as much in fees as the amount of money they borrow (see Figure 1). Those extra charges can create a vicious financial cycle that traps borrowers in unmanageable debt.
Several factors contribute to debt cycles, including a general lack of financial literacy, leading to poor spending choices and using credit cards instead of savings to cover emergencies. Moreover, families and friends are often the top sources of financial advice, according to a Bankrate survey. Still, even well-meaning family members can give bad recommendations or not discuss money issues at all.
To break a cycle of debt, you must be willing to make changes and stick to them over time. This can mean putting aside savings, cutting spending, or taking on a part-time job to earn extra income. Increasing your financial literacy can also help you learn how to avoid predatory lending practices and identify alternative resources for getting the funds you need when you need them most.
Collection Efforts
It’s not uncommon for payday loan borrowers to be pursued by debt collectors. If you find yourself in this situation, you may be bombarded with calls or served a writ of garnishment (that’s a legal order to take money from your wages). If that’s the case, it’s important to contact a creditor law firm immediately. Otherwise, you could be facing unauthorized withdrawals from your bank account, a wrongful charge to your credit report or even identity theft.
Payday lenders are notorious for collecting debts using aggressive tactics. They often attempt to withdraw funds directly from a borrower’s bank account, even when there isn’t enough money to cover the amount owed. This can result in a barrage of overdraft charges that quickly add up. In fact, this practice is illegal in some states, including Minnesota.
Other lenders collect repayment by using an automatic debit from a borrower’s bank or credit card account, or they might ask the borrower to write a post-dated check that will be cashed when the loan is due. In either case, federal laws prohibit payday lenders from conditioning a loan on authorization for such recurring electronic withdrawals or checks.
Many payday loan operators have storefronts, but a newer class of these lenders operates exclusively online. This kind of lender often collects personal information from its borrowers before offering them a loan, and the information can be sold to debt collectors and other companies. In addition, many of these lenders have been linked to international crime rings that target vulnerable individuals with fake debt collection letters and other scams.
Payday loans offer an easy way to access short-term funds, but they come at a steep price. When interest and fees are factored in, a payday loan can be more than 400% more expensive than a traditional personal loan or credit card. If you’re struggling to make ends meet, it’s best to seek help from a financial counselor or debt consolidation company before resorting to payday loans. The best option is to avoid them altogether by preparing for unexpected expenses, finding ways to increase your income or taking on extra work like temporary or gig jobs.
Damage to Your Credit Rating
Payday loans often have exorbitant interest rates and fees, which can amount to 400% or more a year when calculated as an annual percentage rate (APR). When compared with credit card interest rates that typically range from 15%-30% APR and personal loan rates that are generally lower, payday lenders can be very expensive.
These sky-high rates can also be hidden with confusing fee structures and other provisions, making it difficult for borrowers to fully understand what they are getting into when taking out a payday loan. Combined with short terms and a tendency for borrowers to roll over or take out new payday loans to pay off old ones, this can quickly lead to a debt trap from which many borrowers are unable to escape.
Another big risk of payday loans is that they can damage your credit rating, which can make it harder to get credit in the future. This is especially true if you default on the loan and are sent to collection, where you may be subjected to incessant calls from debt collectors who threaten lawsuits or wage garnishment.
Additionally, if you can’t repay your payday loan when it comes due and end up bouncing the check, you can be hit with bounced-check charges from your bank. And if you default on your loan, it can also end up in the public records section of your credit report, which can impact your ability to get credit in the future.
Aside from the financial harm they can cause, payday loans can also have other negative impacts on your health. Research has shown that payday loan borrowers are more likely to experience stress, and this can contribute to health problems. For example, in one study, researchers found that payday loan borrowers had higher levels of C-reactive protein, which is linked to heart disease.
While there are certainly times when a payday loan may be necessary, it’s important to weigh the risks against alternatives before taking out one. You can try to find ways to meet your financial needs without a payday loan, such as by asking your landlord for an extension or working out a payment plan with creditors. Or you could consider alternative emergency loans for bad credit from nonprofits that don’t do a credit check or require collateral.
