Smart Spending

The Trap of the Payday Loan Cycle

Most people know what payday loans (sometimes called cash advance loans) are.  When you’re short on cash you can go to a payday lender and get a quick pick-me-up. This “cheap” short-term loan is supposed to spot you the money so that you can pay your bills on time and then you simply repay the loan when you get your paycheck.  Sounds simple right?  You pay a $15 flat fee (something that is cheaper than the late charges or bounced check fees that might incur otherwise), get your boost to make it to the next payday and then get back on your regular schedule.  What happens too often is the regular schedule becomes: get paid, pay off the payday loan, and take out a new payday loan.

Imagine the scenario.  You are short on cash this month, so rather than bounce a check or get charged late fees you borrow $400 for a flat $15 fee (this is the average fee for this type of loan).  You pay off your bills, and then you get paid.  You buy some groceries, and pay off a few more bills.  Two weeks later you only have $300 left to pay off the loan, so you roll the $100 into a new loan and take out a little more to help you through this month.  You again pay the $15 fee, all the while thinking you are getting a good deal.  But if you took the time to add up the costs, you would realize that you are not getting anywhere.

What ends up happening is that over half the people taking out these loans have trouble paying them back over half the time.  So instead of a one-time boost, it becomes a problem that people get trapped in for months on end.  The average loan amount is $375.  The average interest charges on this loan can quickly escalate to $520 (based on the average length of the loan lasting 5 months).

Those taking out these loans were trying to avoid bounced check fees and late charges.  In the end, they pay those fees and charges, as well as interest on the loan, and they resort to other means of funding such as borrowing from friends, selling or pawning possessions, taking out a longer term traditional loan, or using a tax refund.  All of these options were available in the first place, but the borrower took the lender’s word and thought they could get by with a much cheaper option.

Everyone runs into financial hurdles, it is simply a matter of when.  The key is to be prepared and have your emergency account well funded to avoid the hurdles.  Since too many people fail to plan this way, it is no wonder that borrowers that have been sucked into paying outrageous interest charges favor tighter regulation on almost a 3 to 1 basis as Pew Research recently discovered.  But will stricter regulation actually help people out of their debt problems?  It may be that education and encouragement to save instead of spend is a more efficient use of resources.

Have you ever had to use a payday loan?  Did you end up feeling helped or cheated?