What is so bad about payday loans?
Payday loans are used by millions of Americans every year, despite high interest rates that can reach several hundred percent.
What is a payday loan?
A payday loan is a one to four week loan of less than $ 1,000 that costs about $ 15 to $ 30 in fees for every $ 100 you borrow. When you do the math, that works out to an Annual Percentage Rate (APR) of 360% to 780% for a two week loan.
Loans are generally offered by specialist lenders rather than traditional banks. To be eligible, borrowers only need proof of residency, proof of employment, and a valid checking account.
The payday loan application process does not involve a credit check, and payday loans are generally not reported to national credit bureaus. So taking out or paying off a payday loan is unlikely to hurt your credit rating.
But your credit can be at risk if you don’t pay off your loan, warns the US Consumer Financial Protection Board. “Debt collection could hurt your credit rating,” the agency said.
Your scores can also be affected if payday loan payments prevent you from staying up to date on other bills.
To understand the damage a payday loan can do to a consumer, you can watch the second episode of the Netflix documentary series Dirty money, which focuses on Scott Tucker, the backbone of convicted payday loans, now serving more than 16 years in prison.
Tucker’s company, AMG Services, offered predatory payday loans that were intentionally confusing and involved high administrative fees and deceptive customer service practices. Federal prosecutors said interest rates were as high as 1,000%.
Typically, the interest rate on a payday loan is more than 10 times the rate on a credit card, according to Federal Reserve economist Neil Bhutta in his study. Payday loans and the financial health of consumers.
The high costs often force consumers to take out new loans to pay off existing loans – and they find themselves trapped in a debt spiral.
Why people turn to payday loans
Even with such poor terms, payday loans remain popular: 12 million Americans use them each year.
Borrowers who have lost their financial balance and need instant access to cash often have more to worry about than the high price of loans.
As of August 2019, high interest payday loans have been illegal in 18 states and the District of Columbia. Three states – Maine, Oregon, and Colorado – allow lower-cost payday loans that limit the interest a lender can charge.
Advocates in the payday loan industry have argued that lenders provide a vital service – providing loans to high-risk borrowers when other traditional financial institutions can’t or won’t.
Alternatives to payday loans
Payday loans have been called the “democratization of credit”. But consumers with little or no credit have options, including credit cards and personal loans with much lower interest rates and more regulatory oversight than payday loans.
Additionally, the National Credit Union Administration (NCUA) allows federally chartered credit unions to offer low-value loans called Alternative Payday Loans (PALs). To be eligible, you only need to have been a member of the credit union for at least one month.
You can also consider these other cheaper and less painful alternatives to payday loans whenever you need the money fast.
And then, work on building an emergency fund so that you don’t find yourself in this kind of situation again.
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