Payday Loans for Dummies
I haven’t slammed payday lending for quite a while now, so I figured it’s about time.
What Are Payday Loans?
I’ve attempted in my overly wordy and complex way to explain payday lending in previous posts (see for example Reverse Bank Robbery, Banks Now Payday Lenders , and Wonga: So Wronga), but this 76-second video is the simplest, clearest description of payday lending’s ugliness that I’ve seen.
In the video’s example, John ends up paying seven $75 fees—$525—to borrow $500 for 12 weeks. In APR terms, that works out to about a 390% annualized interest rate that John paid on his $500 loan. Big Ouch.
Why Do People Take Out Payday Loans?
That’s easy: They need money. But that’s a superficial answer. The real question is why does anyone decide that a payday loan is their best option to get needed cash?
Usually—just like in the video with John’s truck breaking down—the need starts with some sort of mini-crisis. And the cohort of consumers payday lenders target are those with few options: No credit, little savings, living hand-to-mouth. A payday loan is simply a quick fix. John’s thought process may have been something like this:
“If I don’t get the truck fixed, I’m going to miss work, and then I’m going to get fired, and then my problem’s going to be a lot worse. I can repay this $500 back when I get my paycheck next Friday. Yeah, $75 is a hefty fee, but it’s better than getting fired.”
Sounds reasonable. Except like many who are chronically short of cash, when John’s payday rolls around, other demands for the money have surfaced, like they always do, and he can’t repay the $500 payday loan. So he coughs up another $75 fee. And so it goes, week after week, until John’s been bled of $525 in seven $75 chunks.
Alternatives to a Payday Loan
Here’s what I would have liked to see John try before going to a payday lender:
- Tap his emergency fund for the $500. Apparently John didn’t have an emergency fund, and avoiding borrowing at the equivalent of a 390% APR is a fantastic reason to get one going. John was able to turn over to the payday lender $75 every two weeks for twelve weeks; if only he could be equally diligent about paying himself, he’d have a tidy emergency fund built up in no time.
- Ask a friend or relative for help. If John’s got a reasonable record of personal responsibility, he could probably find a way to borrow $500 from one or more people close to him.
- Ask his employer for a $500 advance on his pay. Again, if John has a good work record and explains he’s not going to be able to get to work if he can’t get his truck fixed, his employer just may help out. John could offer to work overtime to speed up the payback period.
- Ask his mechanic to allow him to pay the repair bill over a period of time. If John’s got a place where he takes his truck regularly, the owner just may let him pay off a $500 repair over five or ten weeks.
- Find another way to get to work until he saved $500. Maybe John could, temporarily, bum rides to and from work with colleagues. Or maybe he could borrow someone’s bicycle and pedal to work for a few weeks. The exercise would do him good, and the money saved on gasoline could go toward his truck repair fund!
Also, once he got the payday loan, John should have done everything in his power to assure he could pay it off after just two weeks and a single $75 fee. Temporary, second jobs can often be had quickly through local agencies who specialize in providing day labor. And maybe he could sell a few items to raise money. Until that loan was repaid, John should have been doing nothing but sleeping and trying his darndest to earn money.
Payday Loans: Easy to Get In, But Often Hard to Get Out
As John discovered, the seemingly easy, quick fix of a seductive payday loan often turns into a costly nightmare. Habitually borrowing money at the equivalent of a 390% APR makes getting ahead financially pretty much impossible. Most people who take out payday loans probably believe they’ll be able to repay quickly. But then something comes up, as it always seems to, that’s more important than repaying the loan, so it’s rolled over another two weeks. The
leech payday lender is sucking them dry, one $75 drop at a time.
What would you have suggested to John as an alternative to a payday loan?