How payday loans work – biggest dangers and 14 better alternatives (part 2)

June 27, 2019

Part II: Who uses payday loans and what are their dangers?

According to a survey by Bankrate, roughly 25 percent of Americans live paycheck to paycheck. The money they make just barely covers their day-to-day expenses, with little or nothing left over for emergencies. If you’re in this situation, any unplanned expense – such as a $300 car repair – can cause a financial crisis.

Who uses payday loans and why

According to the 2012 Pew report, 12 million Americans take out payday loans each year. About 5.5 percent of all American adults have used one within the past five years.

The people most likely to use payday loans are:

• Young(ish). More than half of all payday loan users are between 25 and 44 years old. About 9 percent of people in their 20s, and 7 percent to 8 percent of people in their 30s, have used this type of loan in the last five years. By contrast, people over 60 years old are unlikely to use payday loans. About 24 percent of all Americans are 60 or older, but only 11 percent of payday borrowers are.

• African American. Most payday borrowers are white, but that’s because white people are such a large group. African Americans, who make up only 12 percent of the population, take out nearly a quarter of all payday loans. Roughly 1 in 8 African American adults have used a payday loan in the past five years, compared to only 1 in 25 white adults.

• Low-income. The median household income in the country was $53,657 in 2014, according to the Census Bureau. However, most payday loan users have income well below this level. More than 70 percent have a household income of less than $40,000. People in this group are three times as likely to use payday loans as people with incomes of $50,000 or more.

• Renters. People who rent are much more likely to use payday loans than people who own their homes. About 35 percent of American adults are renters, but 58 percent of payday borrowers are. About 1 out of 10 renters has used a payday loan in the past year.

• Relatively uneducated or undereducated. More than half of all payday loan users have no education beyond high school. Less than 15 percent of them have a four-year college degree.

• Unemployed or disabled. Payday lenders are perfectly happy to borrow against your unemployment or disability benefits. About 1 in 10 unemployed Americans has used a payday loan in the past five years – although they may have been employed when they took out the loan. Disabled people use payday loans at an even higher rate. Roughly 12 percent have used one in the last five years.

• Separated or divorced. Only about 13 percent of American adults are separated or divorced. However, this group makes up 25 percent of all payday loan users. About 13 percent of separated and divorced adults have taken out a payday loan in the last five years. Payday lenders often market their products as short-term fixes for emergency needs, such as car repairs or medical bills. But according to the Pew survey, most users don’t use them that way. Nearly 70 percent of first-time borrowers say they took out their loans to help pay for basic needs, such as rent, food, utilities, or credit card bills. Only 16 percent say they borrowed the money for an unplanned, one-time expense. When Pew asked people what they would do if they couldn’t use payday loans, they gave a variety of answers. More than 80 percent said they would cut back on basic expenses, such as food and clothing. More than half also said they would pawn something or borrow from friends and family. However, most users did not say they would use credit cards or take out bank loans – possibly because many don’t have good enough credit to qualify.

Dangers of payday loans

The most obvious problem with payday loans is their extremely high interest rates. The fee for a payday loan can be anywhere from $10 to $30 per $100 borrowed, which works out to an annual interest rate of 261 percent to 782 percent. But these loans also have other dangers that are less obvious.

These dangers include:

• Renewal fees. When borrowers can’t pay back a payday loan on time, they either renew the loan or take out a new one. So even though they keep making payments on their loans, the amount they owe never gets any smaller. A borrower who starts out with a $400 loan and a $60 interest payment and then keeps renewing the loan every two weeks for four months will end up paying about $480 in interest – and will still owe the original $400.

• Collections. In theory, a payday lender should never have any problem collecting a debt, because it can take the money right out of your checking account. The problem is, if that account is empty, the lender gets nothing – and you get socked with a hefty bank fee. But the lender usually won’t stop with one attempt. It keeps trying to collect the money, often breaking up the payment into smaller amounts that are more likely to go through. And, at the same time, the lender starts harassing you with calls and letters from lawyers. If none of that works, the lender will probably sell your debt to a collections agency for pennies on the dollar. This agency, in addition to calling and writing, can sue you for the debt. If it wins, the court can allow the agency to seize your assets or garnish your wages.

• Credit impacts. Payday lenders generally don’t check your credit before issuing you a loan. For such small loans at such short terms, it’s just too expensive to run a credit check on each one. However, if you fail to pay back your loan, the credit bureaus can still find out about it. Even if the payday lender doesn’t report it, the collections agency that buys it often will, damaging your credit score. Yet if you do pay back the loan on time, that payment probably won’t be reported to the credit bureaus, so your credit score won’t improve.

• The cycle of debt. The biggest problem with payday loans is that you can’t pay them off gradually, like a mortgage or a car loan. You have to come up with the whole sum, interest and principal, in just two weeks. For most borrowers, a lump sum this size is more than their budget can possibly handle – so they just renew their loans or take out new ones. According to the Consumer Finance Protection Bureau, roughly four out of five payday loans end up being renewed or rolled over to a new loan.

Next Week Part III: Laws about payday lending.

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