Payday Loans—the Most Expensive Way to Borrow

By Remar Sutton, DCU StreetWise Spokesperson

On storefronts, on TV, over the Internet, you've seen the offers for "cash today" with "no credit check"—step right in, pick up the phone, or click that link and you can have $100 to $500 in your account before the end of the day. Just what you need, the ads promise, to tide you over until payday. What does it cost? Just a small fee, say the promoters. Annual percentage rates (APR) typically ranging from 400% to over 1000%, say the facts. Whatever they're called—payday loans, cash advances, check advance loans, payroll advances, deferred deposits or post-dated check loans—such loans are the most expensive way to borrow and for many, many consumers a ticket to the debt treadmill.

Defining a "payday loan"

Payday loans are small (typically under $500), short-term (typically two weeks) loans with high interest rates (typically over 400% APR on a two-week loan). To get a loan the borrower must be employed and have a bank account; the lenders run no credit checks. Fees for borrowing typically range from $15 to $20 per $100 borrowed for two-weeks. If the borrower cannot pay back the loan at the end of two weeks, then the lender typically "rolls" (extends) the loan by charging the loan fees again for the next two week period. Because many people get payday loans because finances are so tight they can't make it to their next paycheck, their chances of being able to payoff the loan with the next paycheck are poor—many end up renewing the loan, adding more fees, and stepping onto the debt treadmill.

How the loan works

If the borrower takes out the loan in person at a payday loan outlet, the borrower usually gives the lender a post-dated check for the loan plus the fee: on a loan of $200 with a $15 per $100 fee, for example, the borrower would write a check for $230 or write a check for $200 and get $170 in cash. At the end of the two-week period, the lender deposits the check unless the borrower has extended the loan or has come in and paid it off and then taken out a new loan with fees for two more weeks, a ploy called "touch-and-go" or "back-to-back" loans that evades some states' regulations of loan rollovers.

If the borrower uses an Internet lender for the loan, the lender electronically direct deposits the loan into the borrower's bank account and the borrower authorizes an automatic withdrawal from the account for the loan and fees at the end of the loan period.

A debt treadmill for payday borrowers

Promoters and lenders of payday loans claim that they are providing an emergency, occasional service to folks who are temporarily short of cash. Analysis of the statistics by the Center for Responsible Lending show that the majority of payday loan borrowers have multiple loans each year. Two of three borrowers have five or more payday loans annually and half of these have 12 or more payday loans annually. Only 33% of payday borrowers use four or fewer payday loans. Some borrowers may also borrow from two or more payday lenders, multiplying the potential for getting trapped in debt.

So how much can it cost to pay off small loans of a couple of hundred when you have to keep rolling the note? A bundle of hard-earned cash. The following are not unusual examples of what can happen.

A consumer borrowed $200 for two weeks for a $38 fee; unable to pay $238 in two weeks, the consumer rolled the note 11 times. The consumer after almost six months had paid over $400 in fees and still owed the original $200.
A consumer borrowed a total of $700 that cost an eventual $1780 to pay off.

Golden profits for the payday lenders

For lenders, payday lending is so profitable (an estimated 34% on sales) that the industry has mushroomed in the last ten years, particularly in states where there is no regulation of this type operation and/or no cap on the APR that can be charged. In states that regulate the loans or that prohibit them, payday lenders are getting around state law by promoting their loans over the Internet while they are based in an unregulated state, using the charter of a lending institution in an unregulated state (rent-a-bank), or just claiming that they aren't subject to usury laws because their "fees" aren't interest. Whatever payday lenders call their fees, payday loans are currently generating an estimated $3.4 billion in fees, according to the Center for Responsible Lending. This figure is probably conservative, notes the study, because bounced check fees (NSF) charged by banks and returned check fees charged by the lenders were not included in the total.

Alternatives to payday loans

So what do you do when your car's brakes or starter suddenly need work and your bank account is low? Or maybe you haven't enough to make this month's mortgage or car payment right on time. Or is it an electric or gas bill there's not enough cash to pay on time? Here a few alternatives and tips for meeting that emergency and preventing it from happening again.

Ask for an advance on your paycheck from your employer. If you have what's truly a small, one-time emergency and can truly afford to pay it out of your next pay check. Many employers are willing to do this occasionally for good employees.
Loan from family member or friend. If you have only a truly short-term need, you might borrow the amount from a family member or friend. If you do, set down your agreement to pay it back, when and how in writing and keep your promise. For example, a family member might be willing to loan you $200 without interest and allow you to pay it back at $50 from each of your next four paychecks, a plan that might be more manageable and affordable than a payday loan, which does not generally allow repayment of the loan in installments.
Put the cash advance on your credit card. Even the highest allowed APRs for credit card cash advances are much lower than virtually any payday loan. And you don't have to give a reason. Just make a written plan—a bargain with yourself—on how you will pay it off and stick to that plan.
Consider paying the late fee on a bill. If you haven't been slipping into a habit of paying your mortgage, auto payment or utility bills late, then the late fee for late payment is usually less than the cost of a payday loan. If you anticipate a problem paying a loan with DCU, then by all means call ahead of time.
Seek a small installment loan. Many credit unions do make such small loans quickly—for example, to cover unexpected auto repairs or to help you consolidate bills. Such small loans are for a longer period and allow you to pay them back in installments. You won't know if such a loan is available to you until you ask.
Seek help with debt management. Don't wait until things are desperate and you run the risk of climbing on the payday loan treadmill. Your credit union DCU provides a number of services in its Financial Wellness and Recovery program to help you get over the crisis and back in control of your personal finances.
For the future, start a savings account. A savings account with even just $300 or $400 in it, can protect your wallet from the temptation for payday loans. It will cost you only pennies to take that $100 or $200 out of savings when you hit a shortfall. Then religiously pay yourself back. Saving something—even just $15 or $20—out of every paycheck can be very important to staying in charge of your personal finances. Making a budget is also important for staying in charge.

For more information on Payday Loans

Payday Loans = Costly Cash, an alert from the Federal Trade Commission (FTC), offers a brief overview and options to using them.

The Consumer Federation of America has released the findings of its recent study of 100 Internet Payday Lenders. Consumers at Risk from Online Payday Lending CFA Survey of 100 Internet Payday Loan Sites <> summarizes their findings and provides a link to a pdf file of the complete report.

The Center for Responsible Lending, based in North Carolina, provides a link to its December 2003 report and numerous other resources.

So, what do you think?

If you find this review helpful, please pass the word to your friends. Also email me with any comments or suggestions.

Remar Sutton

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Reviewed and updated June 2005

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