#WealthforLife Wednesdays: The Real Cost of Payday Loans

Repeat borrowing often results in a cycle of debt

“Fast cash! No credit check! No paper hassles! 100% approval! Bad Credit is OK!” are just some of the advertising messages payday lenders use to promote and entice borrowers to apply for payday loans. These small short-term unsecured high interest loans are borrowed against your next paycheck. Borrowers usually only need a checking account and proof of income to apply.

Advertising like this is what attracted our July/August issue Financial Fitness winner, Jason Scott, to payday loans. “I got stuck in the cycle and when I would pay one payday loan back I would take out another. I just felt that I needed the money but eventually it got out of control and I missed my payments,” Scott explains of how the repeat borrowing became a costly consequence. “It cost me money to take out loans. I paid $90 [in fees] to borrow $300 and was being charged 345% APR. I wasn’t thinking.”

The reality is that these “fast cash solutions” often lead to more debt because most borrowers are not able to pay back the loan by their next paycheck or by the 7 to 30 day due date. Instead they elect to renew, rollover or extend the loan.

In an example provided by the Consumer Financial Protection Bureau, if you roll over a loan multiple times you could end up paying hundreds more in fees. For instance, if you need $300 today, you would have to pay back $345 in a couple of weeks, assuming a fee of $15 per $100 borrowed.  A $15 fee per $100 borrowed is typical. Although $45 may not seem like a lot, look at it this way. If you saved $45 every two weeks, in one year you would have saved $1,170 (not including interest) that you can tap into for emergencies versus turning to payday loans.

If you roll over a $300 loan with a $45 fee three times before fully repaying the loan, you will pay four $45 fees, or $180, and you will still owe the $300 when the extension is over. So, in that example, you would pay back a total of $480—that means you’re spending $180 to borrow $300; almost 400% APR. By comparison, APRs on credit cards can range from about 12% to 30%.

Although many states have banned payday loan rollovers, borrowers still get into trouble by incurring late charges, returned check fees or will often take out another loan to pay off the previous debt making it difficult for them to ever get out from under payday loans. According to a study conducted by The Pew Charitable Trust organization, most borrowers are in debt for an average of five months as a result of renewal fees.

If you are in need of some cash here are some other alternatives to consider:

1. Negotiate your bills. For medical bills call the billing representative and tell them how much you are able to pay and when you are able to pay it. Establish a payment plan that you can truly afford and make sure that you pay the amount you agreed to on time each month. Do the same for your other bills. You’ll be surprised how many creditors will extend your due date without charging you a late fee. Don’t be afraid to ask.

2. Consider a small loan from your credit union. Many offer short-term loans with competitive interest rates.

3. Find out if your states’ Human Resources Administration (HRA) has a cash assistance program. Several nonprofit organizations, such as the Salvation Army, and community groups offer advances or emergency credit.

4. Ask family or friends. But be sure to outline how you plan to pay back the loan, put it in writing and get it notarized.

5. Consider a cash advance from your employer. An advance from your employer is the same concept as a payday loan because it is borrowed against your paycheck, but they don’t come with the excessive fees of payday loans. Just remember that your next paycheck will be lower, so plan accordingly and talk to someone in your human resources department.

6. If you are in a dire financial situation, ask your credit card company if they provide a cash advance. Although the interest rates are often significantly higher than it is on purchases or balance transfers, they are still a lot cheaper than a payday loan. But don’t make a habit of using your credit card like an ATM.

Whatever you choose, remember that there are several cheaper alternatives than a payday loan and you should weigh all your options. But before you get into a financial bind, make it a practice to save and build a healthy emergency fund that you can tap into when an unexpected situation comes up.

Have you ever taken out a payday loan? Tell us your story.

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How a Payday Loan Works by Pew's Safe Small Dollar Loans Research Project

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