If it looks too good to be true, it is probably a payday loan. While payday loans have to disclose in a dollar amount and annual percentage rate regarding how much they cost to borrow, they also rely on repeat business to extend the loan, costing the consumer a rate of nearly 400 percent or more. Whether or not the borrower understands that, it costs them money.
Payday storefronts outnumber Starbucks by about two to one, but do not tend to be located in the same neighborhoods. Marketed towards low-income demographics, the loans build a clientele on recycled debt rather than a long-term positive impact. Repeat borrowers make up 98% of payday loan volume.
A payday loan is a cash advance secured by personal check or paid by electronic transfer. You write a check for the amount you want to borrow plus the fee for borrowing the money. The lender gives you the amount borrowed and agrees to hold your check until your next payday. However, if you came up short on payday, you have to pay new fees to roll over the loan, thus making the borrowed money more expensive each time the loan is extended.
The Federal Trade Commission gives the following example:
Say you need to borrow $100 for two weeks. You write a personal check for $115, with $15 the fee to borrow the money. The check casher or payday lender agrees to hold your check until your next payday. When that day comes around, either the lender deposits the check and you redeem it by paying the $115 in cash, or you roll-over the loan and are charged $15 more to extend the financing for 14 more days. If you agree to electronic payments instead of a check, here’s what would happen on your next payday: the company would debit the full amount of the loan from your checking account electronically, or extend the loan for an additional $15. The cost of the initial $100 loan is a $15 finance charge and an annual percentage rate of 391 percent. If you roll-over the loan three times, the finance charge would climb to $60 to borrow the $100.
It is expensive to be poor!
Once a borrower gets into the cycle, it can be difficult to get out. According to the Center for Responsible Lending, the average payday borrower has nine transactions per year, and remains in payday loan debt for 212 days out of 365.
Avoid predatory lending, whether you are the lender or the borrower. Seek credit counseling or a competent attorney to know what you are getting into and how much it is going to cost you.