Since 2001, payday lending has grown from a $14 billion dollar business to a thriving $46 billion industry, preying on borrowers by saddling them with triple-digit interest rates and an endless cycle of debt. The Consumer Financial Protection Bureau’s (CFPB) new rules attempt to limit the abuse of the payment system, restrict excessive fees, and provide a three-day notice to customers before payment can be deducted from their bank account.
Yet, payday lenders have historically been very good at working through the loopholes in the system. As the CFPB finalizes the new regulations, thousands of lawyers are looking for manipulative strategies to get around the laws. The best solution for consumers is to altogether avoid using this potentially high-risk strategy for short-term loans. Since many borrowers are unaware of the traps posed by payday loans, here’s a quick list of what makes them such a risky way to borrow money, and alternatives to avoid using these predatory lenders.
What makes payday loans so risky?
Deceptive advertising — Many violate the Truth in Lending Act (TILA) by failing to accurately disclose the annual percentage rate and other loan terms, and making pre-authorized debits from consumers’ bank accounts a condition of the loans, in violation of the Electronic Funds Transfer Act (EFTA).
Example: To make emergency repairs to his car, James used a payday lender to borrow $600 with a fee of $120, which works out to 20% interest. However, because the loan term was only 30 days, he failed to realize the annualized interest rate was actually 240% (20% x 12 months)!
- High interest rates — Often 200% to 1,000%…or more! This FTC case highlights two firms who charged clients $975 to repay a $300 loan.
- Short term — Time frame can be 7 to 30 days, which gives borrowers very little time to repay the debt.
- No credit check — The borrower’s credit rating is usually not considered, so those with poor credit, low or paycheck-to-paycheck income, or an inability to acquire a credit card are most vulnerable.
- Military personnel targeting — Military bases — goldmines for predatory lenders — are often surrounded by an excess of payday lending firms, resulting in 22% of military personnel taking out payday loans versus 16% of the civilian popu The CFPB has found many loopholes for military families in the 2006 Military Lending Act, and currently seeks to add additional protections against high-cost credit products.
- Ease of access — In addition to 20,000 payday lenders across the S. — more locations than McDonald’s — borrowers can also apply online, be approved in a matter of seconds, and have amounts as low as $100 deposited directly into a bank account. This offers an enticing solution to pay off even the smallest debts.
- Shady collection practices — Lenders currently require access to a borrower’s bank account to collect payment, which can lead to unanticipated withdrawals or debits, transaction fees, insufficient-funds fees charged by their bank, and returned-payment fees charged by the lender.
- The dilemma of “robbing Peter to pay Paul” — Borrowers often find themselves taking out a second payday loan from another lender to pay the first lender’s initial loan, creating a costly never-ending cycle of debt.
- Excess fees — Lenders typically charge a loan origination fee, and most also offer the option to “roll over” loans to an additional term for added finance charges, often equal to the origination f The CFPB found that four out of five payday loans are rolled over or renewed within two weeks.
Example: Rosa fell behind on her bills due to unforeseen medical expenses. To cover her bills, she took out a $400 payday loan for 14 days with a $90 origination fee (that’s 22.5% interest for 14 days, or 587% annualized interest!), but then could not repay the loan, so she rolled the loan over to a second 14-day term for a second fee of $90. By the time she paid it all off, she’d paid the original $400 and $90 fee, plus three more rollover fees of $90 each, for a total of $760, nearly twice the original loan!
Alternatives and prevention:
Credit unions — Because credit unions are member owned, they tend to promote thrift and positive community Many offer short- term loan programs at much lower interest rates than payday lenders, and without the sneaky fees. Find a reputable credit union near you through the National Credit Union Administration’s Credit Union Locator.
- Banks — Many smaller banks have also recognized the need for small, short-term consumer loans, and are competing with payday lenders by offering these types of loans with much lower interest and low (or no)
- Negotiate a payment plan with creditors — Rather than immediately resorting to a payday loan, call creditors (credit card companies, utility services, healthcare providers, ) and ask to negotiate a payment plan. Often, simple communication is all that’s needed to attain more affordable payments.
- Borrow from family or friends — This can also be a risky option, as borrowing money can put a strain on relationships, so be sure to focus on paying back the loan just as if you’d borrowed from a financial
- Loans for poor credit — Borrowers with less-than-ideal credit can try these options for bad credit loans, including one option for the relatively new peer-to-peer (P2P) loan optio
- Credit card cash advance — This strategy should be used as a last resort since interest rates will be high, but 30% is definitely better than 300%!
- Loans for military members — The Asset Recovery Kit (ARK) program provides a no-interest alternative to predatory lending for active duty, reserve, and National Guard military.
Want to know what additional alternatives are out there? Check out 15 Alternatives to Payday Loans for more options.
We hope this invaluable consumer information will help you, a friend, or family member avoid high-risk borrowing through a payday lender.
