Payday loans are short-term, high-interest loans that borrowers promise to repay out of their next paycheck. Also known as cash advances or check loans, payday loans allow people to borrow a small amount of money quickly.
To get a payday loan, the borrower writes a postdated check for the loan amount plus a fee, generally $15 to $20 per $100 borrowed. The lender agrees to hold the check until the borrower’s next payday, usually two weeks. When that day comes around, the borrower can either allow the check to be deposited, or they can pay back the loan in cash and have the check returned. If the borrower doesn’t have enough in their account to cover the check, they will incur overdraft fees from their bank in addition to the payday lender’s fees.
Payday loans are meant to help borrowers cover small, unexpected expenses between paychecks. However, the fees can add up quickly, making these loans expensive for those who use them regularly or roll over the loan multiple times. Low income individuals, those without access to mainstream credit, and military members are among the most frequent users of payday loans.
Pros of Payday Loans
Payday loans provide fast access to cash when you need it. Unlike traditional loans, payday lenders do not require a credit check or collateral. The minimal requirements make payday loans easy to qualify for. You generally only need proof of income, a bank account, and identification.
The quick cash can be very helpful in emergencies. If your car breaks down and you need money for repairs, a payday loan could provide funds the same day or next business day. This allows you to get your car fixed and get back on the road quickly. Payday loans are also useful for unexpected medical bills, home repairs, late rent payments to avoid eviction, or other pressing financial needs. The fast approval process gets you the money you need right away.
Payday loans serve people who may not have access to other forms of credit. If you have bad credit or no credit history, banks and credit card companies are unlikely to approve you. Payday lenders offer an option when you have been rejected elsewhere. The easy qualifications allow almost anyone to be approved.
Cons of Payday Loans
Payday loans are notorious for their high fees and interest rates. Annual percentage rates (APRs) on payday loans can range from 200% to over 500%, with an average around 400%. This means borrowers often pay more in fees and interest than the amount they originally borrowed.
For a two-week $100 loan, borrowers may pay a fee of $15-$30. This translates to an APR of almost 400%. If the borrower cannot repay the loan after two weeks, they can renew or “roll over” the loan – but this leads to additional fees. Borrowers can end up in a cycle of renewing the loan and accumulating more fees, making it difficult to ever fully repay the debt.
Payday lenders target vulnerable and financially insecure populations. They heavily advertise in low-income neighborhoods and communities of color. Studies show payday borrowers are disproportionately people of color, single mothers, renters, those without a four-year college degree, and those earning below $40,000 per year. Payday lenders also target military members and their families.
The payday loan debt trap exacerbates financial hardship for many borrowers already living paycheck to paycheck. Default rates are high, as borrowers struggle to repay loans with interest rates up to 500% or more. Payday loans do not consider the borrower’s ability to repay – leading to a vicious cycle of debt that causes further financial harm.
Payday Loan Industry
The payday loan industry in the United States is a large and controversial one. Major players in the industry include companies like Advance America, Check Into Cash, Ace Cash Express, and many others. These lenders issued an estimated $29 billion in loans in 2018 alone.
The industry is lightly regulated compared to traditional banks. The main piece of federal regulation is the Truth in Lending Act, which requires lenders to disclose all fees and the annual percentage rate. In addition, some states have laws capping interest rates or limiting the number of loans a borrower can take out. However, the industry has proven adept at finding loopholes in state laws.
The payday loan industry lobbies aggressively to ward off regulation. Lenders argue that they provide an important service to underbanked consumers who need quick cash and cannot access other forms of credit. But consumer advocates say the astronomical interest rates can trap borrowers in cycles of debt. Studies have found effective interest rates can exceed 400% APR when all the fees are factored in.
Reform efforts at the federal level have stalled in recent years. The Consumer Financial Protection Bureau adopted new regulations in 2017, including requiring lenders to assess a borrower’s ability to repay, but key parts of the rules were struck down after industry lobbying. For now, the patchwork of state laws remains the main line of defense against predatory lending practices. But the public debate continues as reformers push for lower caps on interest rates and payments.
Alternatives to Payday Loans
Payday loans can seem like an easy solution when you need cash quickly, but they often create a cycle of debt that’s hard to escape. Thankfully, there are healthier financial alternatives to explore first.
Credit Cards
If you have a credit card with available credit, you may be able to do a cash advance for a similar fee to a payday loan. This can provide fast cash, but should still be used sparingly. Try to pay it off quickly to avoid accumulating interest charges. Using a credit card responsibly helps build your credit score over time.
Payment Plans
Many monthly bills like utilities and cell phones offer payment plans if you fall behind. Contact them to see if a payment plan can be arranged before resorting to payday loans. This allows you to pay what you owe over several months. Just be sure to follow the payment schedule.
Borrow from Family or Friends
Turning to family or friends you trust for a loan may be an option. Offer to sign a contract detailing repayment terms. Be sure to follow through on repaying the money on time. This can strengthen relationships when handled responsibly.
Personal Loans from Banks
Banks and credit unions offer personal installment loans with much lower rates than payday loans. Rates are based on credit, so those with poor credit may pay higher rates. But even a higher rate is better than payday loan rates. Payments are spread over many months or years, making them more manageable.
Financial Literacy
Financial literacy is crucial for avoiding reliance on payday loans. Many people struggle with budgeting, saving, and understanding key financial concepts like interest rates and debt cycles.
Learning how to budget allows you to track expenses, reduce unnecessary spending, and ensure you have enough money to cover necessities each month. Budgeting tools like spreadsheets or budgeting apps can make this process easy. Sticking to a budget prevents overspending and reduces the need for short-term loans.
Saving money provides a financial cushion and cash reserves for unexpected expenses. Experts recommend saving at least 3-6 months worth of living expenses as an emergency fund. Automated transfers from checking to savings each month make saving effortless. Even small amounts add up over time.
Understanding interest rates on loans and credit cards helps consumers make informed decisions. Payday loans often have very high APRs of 400% or more. By comparison, credit cards average 15-30% APR and personal loans 10-15%. Taking a payday loan often leads to escalating debt due to triple digit interest rates.
Avoiding debt cycles is critical. Payday loans make it easy to repeatedly renew loans and pay only interest fees. This puts borrowers in a cycle of rolling over debt. It’s important to have a plan to pay off any loans in full by the due date without having to take out new debt. Financial education and discipline can help break debt cycles.
Gaining financial literacy skills in budgeting, saving, interest rates, and avoiding debt traps empowers consumers to make wise financial choices and avoid reliance on predatory payday lending.
Predatory Lending
The payday loan industry has faced criticism and reform efforts due to concerns about predatory lending practices. Here are some of the main criticisms and issues:
-
Excessively high interest rates – Payday loans typically charge 400% or higher APRs (annual percentage rates). These high rates make it difficult for borrowers to pay off the loans and lead to cycles of debt.
-
Targeting vulnerable populations – Payday lenders disproportionately target low-income, minority, military, elderly, and other vulnerable borrowers. These populations often have limited financial options and fall into debt traps.
-
Lack of underwriting – Payday lenders typically do not assess a borrower’s ability to repay. This can set up borrowers to default on loans.
-
Aggressive collection practices – When borrowers cannot pay, some payday lenders use aggressive tactics like harassment and lawsuits to collect. This further burdens indebted borrowers.
-
Loopholes in regulations – Payday lenders have found ways to skirt regulations meant to protect consumers. For example, they may register as other types of lenders or shift to high-cost installment loans.
To address these issues, reform advocates have called for lower rate caps, restrictions on repeated borrowing, and stronger regulatory oversight of payday lenders. However, the industry has pushed back against many proposed regulations. Predatory lending practices remain a major concern surrounding payday loans. More work is needed to protect vulnerable consumers while still allowing access to small-dollar credit.
Stories from borrowers
Many borrowers find themselves trapped in cycles of debt due to payday loans. Here are some real stories that illustrate the impacts these loans can have:
Sarah’s story
Sarah took out a $300 payday loan when her car broke down and she didn’t have the money to get it fixed. She planned to pay it back with her next paycheck in two weeks. But when the due date came, she didn’t have enough to pay back the full amount due. The lender offered to roll over the loan to the next pay period if she paid the interest owed – so she did. This started a cycle where she would pay the interest every two weeks but could never seem to pay off the principal. After several months she had paid over $500 in interest but still owed the original $300.
James’ experience
James lost his job but still had bills to pay. He took out three separate payday loans from different lenders totaling $900. When the loans came due on his next payday, he didn’t have the funds to pay them back. He went from lender to lender rolling the loans over for months, having to pay all the interest and fees. It took him over a year to finally pay back the $900 in principal, and in the end he had paid well over $2,000 in fees.
The impact on families
For parents living paycheck to paycheck, a payday loan can mean not being able to buy groceries or pay the electric bill. Many families have to make difficult tradeoffs when payday loans take up a big portion of their paycheck. The high interest rates mean they continue falling further behind. Some parents get trapped renewing loans for months, which leaves less money to provide food, clothing and other necessities for their children.
Reform Efforts
There have been several efforts to reform the payday loan industry and protect consumers from predatory lending practices.
Legislation
-
In 2006, Congress passed the Military Lending Act which put a 36% interest rate cap on loans made to active duty military members and their families. This helped protect military families from predatory payday lending.
-
Several states have enacted laws capping interest rates on payday loans between 36-45%. States with rate caps include Arizona, Arkansas, Colorado, Connecticut, Georgia, Maryland, Massachusetts, Montana, Nebraska, New Hampshire, New York, North Carolina, Ohio, Oregon, South Dakota and Washington D.C.
-
The Consumer Financial Protection Bureau implemented new regulations in 2017 requiring payday lenders to determine if borrowers can afford to repay their loans. This “ability-to-repay” standard aims to prevent debt traps. The rules were later repealed under the Trump administration.
Advocacy Groups
-
Consumer advocacy groups like the Center for Responsible Lending and the Pew Charitable Trusts have called for more regulation of payday lending at both the state and federal level. They argue that interest rate caps are needed to prevent predatory lending.
-
Faith groups and coalitions like the Stop the Debt Trap Campaign have pushed for reform through grassroots organizing and protest. They view payday lending as an immoral practice that takes advantage of the financially vulnerable.
Alternatives
-
To provide alternatives to payday loans, some non-profits and credit unions offer small dollar loans at much lower interest rates. These programs help consumers avoid predatory payday lending.
-
Employers like Walmart have started offering workers early access to their paycheck through financial technology apps. This can help workers avoid using payday loans to cover emergency expenses between pay periods.
-
There is bipartisan support for postal banking – allowing the US Postal Service to provide basic financial services like small loans. Postal banking would provide a public option to payday lenders.
The future of payday loans
The payday loan industry faces an uncertain future due to shifting regulations and changing consumer preferences. Here are some of the key trends that may shape the industry going forward:
Industry trends
-
Consolidation – The payday loan industry is highly fragmented, with many small local and regional players. However, larger national chains are acquiring smaller companies and consolidating market share. Industry leaders today include Advance America, Check Into Cash, and ACE Cash Express.
-
Growth of online lenders – As consumers shift to digital channels, many payday lenders now offer loans through websites and mobile apps. This allows for more convenience and privacy for borrowers. Major online lenders include CashNetUSA, Speedy Cash, and 247FastFunds.
-
Focus on repeat customers – With new regulations limiting rollovers and renewals, payday lenders are focused on building long-term relationships with repeat borrowers. They aim to become the preferred source for short-term credit even as loan amounts are restricted.
Regulation outlook
-
Stricter rules on state level – States continue to implement lower limits on fees, loan amounts, and repayment terms. New laws may require lenders to consider borrowers’ ability to repay. However, regulation varies widely by state.
-
Potential federal regulation – The CFPB may implement nationwide regulation for payday loans, including restrictions on high-interest lending and requirements to vet borrowers. But lobbying efforts and legal challenges could delay or alter new rules.
-
Pushback from lenders – The payday loan industry will likely challenge new regulations in court and hire lobbyists to influence policymakers. Lenders argue rules should balance consumer protection with preserving access to credit.
Potential changes
-
Decline of small storefronts – With regulatory caps on fees and loan sizes, many small retail payday lenders may go out of business. Stores could close while online lenders gain share.
-
Shift from payday loans to other products – Some lenders may push longer-term installment loans, credit cards, and lines of credit to adapt to new regulations on short-term payday lending.
-
More partnerships with banks – To reduce regulatory scrutiny, payday lenders may partner with banks and market loans under bank brands, taking advantage of looser rules for banks.
-
Focus on technology and analytics – Lenders will leverage data and AI to better target marketing, underwrite loans, and manage risk as regulations tighten. Improved technology could also reduce costs.
The future is uncertain, but payday lenders will likely continue adapting their business models amid evolving regulations and consumer trends. The industry may look quite different in 5-10 years.