Copyright © 2001-2013
Credit Union National Association Inc
The Payday Loan Trap: Don't Get Caught
You need money—$300 to be exact. You feel like you have no alternative, and the cash on those billboards is inviting.
So you visit a payday loan outlet.
Mouse over the image to find out the annual interest rate for that $300 payday loan."
How Much are you Paying for that Loan?
If you want to borrow $300 from a payday lender, you pay a fee, usually $20 per $100 that you borrow. So you write a check to the payday lender for $360.
At the end of the two weeks, if you're like most people, you have to roll the loan over and pay another $60. The $120 you pay to borrow $300 for one month translates into a 520% annual percentage rate (APR).
The annual percentage rate is calculated on the cost of rolling the loan over every two weeks, for a year.
You calculate it by multiplying the two-week interest charge ($60) by 26 two-week periods per year ($60 x 26 = $1,560). You'd pay $1,560 to use $300 for one year.
To figure out the annual percentage rate, divide the amount you'd pay for the loan in a year, by the loan amount: $1,560 /300 = 5.2. Multiply by 100 to get 520%.
Some sources say they've seen payday loans with APRs as high as 7,000%!
Close You write a check for $360. The lender gives you $300 in cash, and keeps $60 for her fee. She says she'll cash the check you wrote in two weeks, unless you return to roll over the loan .
Renewing the Loan
A loan renewal, called a rollover. will give you two more weeks to repay it. It also means you will have to pay the fee again.
This is a true story. A member of Florida Central Credit Union (FCCU) used a payday loan outlet to borrow $300.
By the time she turned to her credit union for help, the woman had paid $1,100 in fees on the $300 loan. And she still owed the original $300!
She also owed money to six different payday lenders, says FCCU CEO and President, Ed Gallagly.
"This is very common. Herein lies the real problem with payday loans," explains Gallagly.
The real problem
Can't Pay it Back
"If someone goes into a payday lender and gets $300, and two weeks later they pay the $300 back plus a $30-$50 fee, the cost for that loan for two weeks is exorbitant," says Gallagly.
But, he adds, "I don't really criticize the payday lender for that." The abuse comes in when the customer can't pay the loan back in two weeks.
Gallagly says that 80%, or eight out of 10 people who use payday lenders, can't repay all of it on the next payday.
Many people find themselves short of cash—especially when they just start out on their own. "Payday-to-payday is how most of us live," says Jim Blaine, president and CEO of State Employees Credit Union.
Payday loan commercials tell you it's quick and easy to borrow: you write a post-dated check and they give you cash on the spot. They hold the check, and don't cash it until your next payday.
The commercials don't mention that you're paying outrageous amounts for the loan. Payday lenders know that if you didn't have enough money this payday, you probably won't be able to pay your other bills, plus the loan, next payday.
They count on you to roll the loan over. And over. And over. That small fee quickly adds up to a sum larger than the original loan.
"If you talk to the trade association for the payday lenders, they say rollovers are infrequent, but that's not true and they know it," says Blaine.
What about me?
Keep your credit report clean.
Keep your Credit Report Clean
John Caskey, professor of economics at Swarthmore College in Swarthmore, Pa. says, ". people don't realize the significance of just walking out on a credit card bill. They don't realize that's going to follow them for a long time."
It shows up in your credit report, which reveals, among
other things, whether you've paid your bills and loans on time, and the amounts you've owed. That's why it's essential that you:
- Pay your cell phone bill on time;
- Make at least your minimum credit card payment each month:
- Send your car payment in on time.
It may not seem important now, but later when you want to buy a new car or a house, you'll be glad your credit record is clean.
Roughly 10% of all payday loans are made to people ages 18-25. The cell phone bill is due and they don't have the money. And it's a big one.
Why Payday Loans?
Young adults typically take out payday loans for three reasons:
- They have bad or no credit histories and can't get loans from credit unions or banks;
- They don't understand how expensive these loans are;
- It's easier and quicker than applying for traditional loans.
That's why it's so important to start saving now. "You can count on needing money when you least expect it. Start saving for emergencies at an early age," says Vicki Jacobson, president of the Foundation for Credit Education in St. Louis, Mo.
Is a pawnshop loan a better deal?
Pawnshop loans represent the bottom of the credit line.
Pawnbrokers don't look at customers' credit histories or checking accounts because pawnbrokers can sell borrowers' property if they don't repay the loans. Here's how it works:
"You show the pawnbroker your watch. He decides it's worth $100. The pawnbroker lends you some fraction of that—about half the resale value," explains John P. Caskey, professor of economics at Swarthmore College in Swarthmore, Pa. and author of Fringe Banking: Check-Cashing Outlets, Pawnshops, and the Poor.
"He keeps your watch as collateral while the loan is outstanding. If you don't repay the loan, the watch becomes the pawnbroker's property, and the debt is extinguished.
. and the pawnbroker places your watch in the display case for sale" says Caskey.
You haven't put aside any money for emergencies, and you lose your job. Bills still come in.
Payday lenders lure you with their friendly service and ease of use. They don't run a credit check, and you walk out the door with cash in your hand. Many payday lenders even stay open 24 hours a day. What could be easier?
"You go into one of these places to cash checks or to get a payday loan, and they treat you like a friend," says Gallagly. "Their software for check cashing and payday loans is very sophisticated. They build up a database on you."
"They know you; they know your family, Gallagly adds. They know if you're married; they know if you have children; they know your birth date."
The convenience comes at a price—your loan's completely to the payday lender's advantage.
If you are tempted by a payday loan, check your credit union first.
If you are tempted by a payday loan, check your credit union first. Some credit unions offer a lower-cost small loan with an APR between 15% and 18%. Compare that to a payday lenders' rate of 500% or more.
At Florida Central Credit Union, "we're realistic enough that we don't make the loan for two weeks," Gallagly says. "We ask, 'how much do you feel you could comfortably pay a week?'"
Gallagly says Florida Central gives lenders a payment period "more like three months, six months, nine months, or twelve months."
Other credit unions, like State Employees Credit Union, offer members another kind of alternative to payday loans. Members can borrow up to $500 at 11.75% APR—which amounts to about $2.50—for two weeks.
Compare this to a payday loan of $500 at 520% APR—which amounts to $100—for two weeks.
Do your research
Borrowing money is a business relationship, Blaine explains. A lot of young adults don't realize that they can negotiate the terms of a loan.
"If you don't know that borrowing money is negotiable, don't know how to bargain, and don't know what the best price is, then you're always at a disadvantage," says Blaine.
Compare borrowers who use different lenders.
Compare Different Borrowers
Category: Payday loans