Supporters of payday loans claim they provide a valuable service to the community by offering loans to people who would otherwise never qualify for credit. They’ll reason that payday loans are not meant as long-term loans but one-off deals to bridge the gap when people are strapped for cash. Although there are circumstances when a payday loan can make sense, the truth is they usually make borrowers’ plight worse. Which is why politicians and regulators throughout the country are taking a close look at this predatory form of lending.
In 15 states, payday loans are already prohibited or illegal and they have interest caps in five states more.
Three Good Reasons Why Payday Loans Are Bad News for Consumers
Payday Loans Are Designed to Push Borrowers Deeper Into Debt
You only need three things to qualify for a payday loan: have a job, be too broke to pay your bills, and to be willing to pay ridiculously high fees for cash. That’s it. Payday lenders will ask for a bank account number and proof of income, but most won’t even bother to check your information. Generally, if you have a pulse, you’re approved. There is a good reason for that.
Payday lenders prefer borrowers who can’t afford to repay their loans and are forced to fall into a cycle of debt, and the terms they offer are designed to do just that. Instead of breaking a loan into small installments, as most loans do, payday loans require payment in full, often after just 15 days. In most cases, the financial difficulties that pushed borrowers to purchase payday loans have not changed and they don’t have the cash to cover the loan. Although payday loans usually only have a two-week term, the average borrower is in debt for 7 months out of the year, which amounts to 14 cycles of payday loans and fees.
Payday Loans Are Expensive
It is worth highlighting how outrageously expensive payday loans are. According to a 2013 report by the Consumer Financial Protection Bureau, the average payday loan borrower pays $574 in fees every year. The APR on a payday loan ranges between 300% and 700%, enough to make a loan shark blush.
Payday Lenders Share a Shady Relationship with Big Banks
While the few big banks who meddled in payday loans, such as Wells Fargo, U.S. Bank and Fifth Third, are exiting from the short-term loan business, it doesn’t mean they are not profiting from it. According to a report by The Guardian, Wall Street banks have invested $5.5 billion in offering credit to the payday lending industry. Banks and payday lenders have a cozy relationship that allows payday lenders to access their customer accounts whenever they choose. This allows banks to profit handsomely from a tainted industry without getting their hands dirty.
The Payday Loan Trap — and How to Avoid It
Banks that offered short-term loans (another word for payday loans) and payday lenders often defend their business model by claiming it offers help to customers who need urgent assistance and would not qualify for a traditional loan. They claim the high interest rates are a necessary evil to keep such high-risk loans available. This is simply not true.
Instead of helping people who don’t have access to credit, payday loans create even greater financial hardship for their users. According to a study by a University of Chicago Business School doctoral student who compared similar households in states with and without access to payday loans, access to payday loans increases the likelihood of a family having difficulty paying bills and lead to a delay of medical care and purchases of prescription drugs.
The good news is that there are alternatives. Lenders, such as Rise and LendUp, provide personal loans to borrowers with bad credit but are less likely to push them toward a cycle of debt. Find a personal loan that fits your needs by using SuperMoney’s personal loan search engine. The search engine allows borrowers to filter loans by credit score requirements, loan amount, and interest rate.
Audrey Henderson is a Chicagoland-based writer and researcher. She holds advanced degrees in sociology and law from Northwestern University. Her writing specialties are sustainable development in the built environment, policy related to arts and popular culture, socially and ecologically responsible travel, civic tech and personal finance.