What You Need to Know About Payday Loans

Let’s talk payday loans. From a personal finance standpoint, they’re easy to criticize: they have high interest rates, large fees and you have to pay them back all at once. But what those criticisms miss is the necessity these services play in people’s lives.

What are payday loans?
A payday loan is a cash advance on a paycheck. The loan is tied to that paycheck and is expected to be paid back all at once. The loan is short term, and has high interest rates -- they can be as high as 500%. You also typically must pay a fee upfront for the loan.

To get a payday loan, you simply need paycheck stubs and a checking account. There is no credit check or down payment like with other lending services.

The Pew Trust has a great video explaining the process.

Who uses them?
According to data from Pew (which is a little old as it’s from 2012), most payday loans are sought by white women between the ages of 25 and 44. There are five groups of people who have higher odds of taking out payday loans: folks without four-year degrees, renters, African Americans, those making under $40,000 annually and those who are separated or divorced, the data shows.

These folks use payday lenders instead of putting things on a credit card because they don’t have strong enough credit to borrow from mainstream lenders. This is important -- the people who take out payday loans aren’t served by other markets. This is why they keep returning to payday lenders, instead of going elsewhere.

Why do people use them?
Many folks are using these loans to cover normal expenses like the utility bill, rent or other monthly bills, according to Pew. This is what makes these loans especially difficult to get out from under.

Once you take out one loan for rent, you then have to spend time paying that back before you’re able to pay for the next month’s rent. Because both rent and income tend to be the same each month, it’s a cycle that continues on and on for many folks, depriving them of their hard-earned money.

Why are they harmful?
There are several reasons. First, and foremost, the high interest rates make these loans extremely difficult to pay back. The payments up front are an added cost, which can make them even more difficult to take care of.

As evidenced by some of the demographic information above, payday lenders tend to prey on folks who are already struggling financially. A payday loan can add to other challenges these folks face.

I’m in a tight spot with my money, what can I do instead?
You have several options. You can go to your credit union or bank and ask for an unsecured loan. The loan’s terms will not be as restrictive as the payday loan, and will often have a better timeline to be paid off.

You can call your utility company, landlord, or other bill collector and ask for an extension. This is especially helpful if you have a good track record with on-time payments.

Look at your checking account. It may have overdraft protection that allows you to spend money that you don’t have in your account, with the expectation that you deposit that money ASAP. While this may not be an ideal situation, it is a way to avoid high interest rates.

Peer-to-peer lending services are also another option. Again, they don’t have such high interest rates or predatory lenders. Your options include Kiva, Lending Club and Prosper, among others.

Longer term, work to consider how you can increase your income and cut back on expenses to ensure that you’re not in this spot again.

I understand the risks of payday loans and want things to change. What can I do?
The Consumer Financial Protection Bureau, which was created to protect consumers following the Recession (and it was Elizabeth Warren’s idea!) is now avoiding implementing the Payday Lending Rule, which would regulate the industry.

You can also learn more about the payday loan market and what you can do to take action is to go to Stop The Debt Trap’s website.