Payday Loans—Still the Most Expensive Way to Borrow

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July 2007

Countless advertisements on storefronts, on TV, in print media, and over the Internet entice cash-strapped consumers with offers of “cash today” with “no credit check”—just borrow against your next paycheck. Since my 2004 StraightTalk Report on payday loans, the industry has continued to grow dramatically, particularly on the Internet.

Payday lenders hawk their loans as a useful “service” that helps consumers meet short-term, emergency needs for cash at a modest cost. The facts tell a different story. About ninety percent of revenue for payday lenders comes from borrowers who can’t pay off their loans at the end of their two-week term and pay additional fees to extend or “flip” the loan, according to a well-researched report by the Center for Responsible Lending. Annual percentage rates (APR) typically range from 400% to over 1000%. Borrowers of a $300 loan often end up paying back well over $700.

Payday loans go by several names—payday loans, cash advances, check advance loans, payroll advances, deferred deposit loans or post-dated check loans—but whatever they are called, such loans are the most expensive way to borrow and for many consumers lead to a cycle of debt that’s hard to break.

Defining a “payday loan”

Payday loans are small (typically under $500), short-term (typically two weeks) loans with high interest rates (typically around 400% APR on a two-week loan). To get a loan the borrower must be employed and have a checking account. Lenders do not run credit checks but do collect personal financial information. Fees for borrowing typically range from $15 to $20 per $100 borrowed for two weeks. The loan is structured so that the borrower cannot pay in installments but must pay off the total amount at the end of the loan term. 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 or “flips” the loan by writing a new loan (with new fees) to pay off the original or previous loan. Data from states that collect the information and from the filings of public loan companies indicate that the average annual number of payday loans per borrower ranges from 6 to 12.

How the loan works

To obtain a loan at an actual payday loan outlet or store, the borrower usually gives the lender a post-dated check for the loan plus the fee. On a loan of $200 with a typical $15 per $100 fee, for example, the borrower would write a check for $230 to receive $200 in cash 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 by paying new fees or has paid it off and then taken out a new loan with fees for two more weeks. Paying off the loan and immediately taking out another is a ploy called “touch-and-go” or “back-to-back” lending that evades some states’ regulations of loan rollovers. If the lender deposits the check when the borrower doesn’t have enough money in the account to cover the check, the borrower will also incur bank and lender fees for the bounced check. Too frequently, consumers report, a lender may use the threat of a bounced check and damaged credit to coerce loan renewals.

The greater danger of Internet payday loans

To very high loan costs, Internet payday loans add the dangers of security risk and potential fraud. In an online payday loan transaction, 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 (or during the loan period). To set up this arrangement, borrowers have to provide their checking account number, routing number, and usually other personal information such as Social Security Number, birthday, mother’s maiden name, and the like. With all this information, the lender has open access to your checking account. Nothing prevents unscrupulous lenders from making multiple charges, making unauthorized charges or automatically “renewing” the loan and continuing to take your money. There are numerous borrower complaints of these types of withdrawals from their accounts. In the worst cases, their account has been wiped out and/or identity theft has occurred.

Although there are certainly reputable online payday lenders, consumer advocates and government consumer agencies note that there are also huge numbers of disreputable and fraudulent online lenders or loan websites. It’s often hard to tell the difference. Many online lenders provide little information about the company and make it hard to contact them. A number of online lenders are located outside the U.S. Other websites aren’t lenders but pass borrowers’ information along to lenders who are “hidden” from the borrowers. Within the U.S., online lenders are often based in states with less regulation of payday loans and illegally market their loans to individuals in states with tougher regulations or with laws prohibiting payday loans. There are so many companies and many are so hard to locate, that law enforcement efforts have been able to do little to curtail fraud and illegal lending activity.

A scary trend: I’ve also noticed an increase in payday lender websites that are set up to look like they are providing sound consumer advice and information about payday loans, but their actual purpose is to sell you their loan.

A debt nightmare for payday borrowers

So how much can it cost to pay off small loans of a few hundred dollars when you have to keep rolling the note? A bundle of hard-earned cash. The following examples are typical 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. After almost six months the consumer 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.
• A consumer applied online for $300 and discovered that the lender, without her knowledge, also charged her for a credit card for which she did not apply. The lender also kept deducting amounts weekly from her account until the amount exceeded $600. The lender provided no information online about how to pay off the total balance of the loan and was difficult to contact by email or phone. The money kept going out of the consumer’s account until she closed her account. Then she got threatening collection calls.

Golden profits for the payday lenders

For lenders, payday lending is so profitable that the industry continues to mushroom. Revenues are an estimated $28 billion a year. Of this, an estimated $4.2 billion comes from excessive fees, according to the Center for Responsible Lending. This figure is probably conservative, notes the study, because fees from four payday loans annually were considered reasonable and not included in the excessive-fee figure. In addition, 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 suddenly need work and your checking account is low? Or maybe you have an unexpected medical expense? Here are a few alternatives and tips for meeting that emergency and preventing it from happening again.

• Check the options at your credit union first. CCU provides personal loans to members that are quick and easy to apply for and have reasonable rates. Such small loans are for a longer period than payday loans and allow you to pay them back in installments.
• Start saving a small emergency fund today. Saving a small emergency fund in your CCU Share Savings Account or All Purpose Savings protects you against unexpected expenses. If you can afford $50 every two weeks to roll a $300 payday loan, you can save $300 in three months. If you have an emergency, you can draw on these savings.
• Ask for an advance on your paycheck from your employer. If you have what’s a small, one-time emergency and can afford to pay it out of your next paycheck, this may be an option. Many employers are willing to do this occasionally for good employees.
• Loan from family member or friend. If you have a short-term need, you might borrow the amount from a family member or friend. If you do, put in writing your agreement to pay it back indicating when and how 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. This plan 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.
• 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 may provide a number of services to help you get over the crisis and back in control of your personal finances.

For more information on payday loans

The website www.paydayloaninfo.org is provided by The Consumer Federation of America. It offers a wide range of information about payday loans, including copies of its research.

The Center for Responsible Lending, based in North Carolina, provides a section on payday lending that includes a link to its December 2006 report and numerous other resources.

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

Prepared for Corning Credit Union by Remar Sutton & Associates, July 2007. All rights reserved.