The pros of payday loans
Here’s why some people turn to payday loans, despite the often negative consequences:
Pro 1: They’re easy to access
The number one advantage of payday loans is that they’re easy to access. In fact, many cash advance lenders promise access to cash within 24 hours and an immediate lending decision. Some are even available 24 hours a day, 7 days a week and have online applications.
Unlike traditional loans, which can take time to apply for, these loan applications can take as little as five minutes.
Pro 2: They have fewer requirements than other loans
Traditional lenders usually require a Social Security number, photo ID, proof of income, a credit check and will verify your ability to repay a loan. Unlike traditional personal loans, most “fast cash” loans have fewer requirements to apply.
Generally, all you need to apply for a payday loan is to:
- Be at least 18 years of age
- Have a government-issued ID or Social Security number
- Have a regular job or other regular source of income
- Have an active bank account
While having fewer requirements makes getting cash more convenient, keep in mind that the additional requirements from banks and other lenders were often put in place to help protect you.
Pro 3: They don’t check your credit
Unlike traditional loans where you need good credit to be approved, payday loans don’t require a credit history. Since they don’t pull your credit, that also means no hard credit inquiry, which can lower your credit score by several points.
Except in rare cases, however, payday loans won’t help build the credit you need to move onto higher quality financial products in the future.
Pro 4: It’s an unsecured loan
Unlike a car title loan, traditional auto loan or mortgage, payday loans are not secured by personal property. This means that if you default (don’t pay), the lender can’t seize your property as a consequence.
While not secured, payday lenders often have access to your bank account as a condition of the loan, which is a different type of risk. They can also take other measures, such as sending your debt to collections or taking you to court over outstanding balances.
The cons of payday loans
When it comes to payday loans, the Federal Trade Commission, a government regulatory body focused on preventing fraudulent, deceptive and unfair business practices, states:
“The bottom line on payday loans: Try to find an alternative. If you must use one, try to limit the amount. Borrow only as much as you can afford to pay with your next paycheck – and still have enough to make it to next payday.”
Which brings us to the first disadvantage of payday loans. …
Con 1: They’re expensive
Depending on the state, payday loans have high interest rates that average about 400%. For comparison, many personal loans charge about 4%-36% interest, while credit card interest ranges from about 12-30%.
Payday loans are sometimes harder to pay back than a traditional loan, because the lender did not verify your ability to repay before lending you money. Payday lenders don’t generally assess your debt-to-income ratio or take your other debts into account before giving you a loan either.
Con 2: Payday loans are considered predatory
A predatory loan is defined as having unfair, misleading or unaffordable terms and has the potential to trap users in a cycle of debt. Payday loans are viewed as a type of predatory loan because of the high costs that can escalate quickly.
Some warning signs of predatory loans include:
- The lender doesn’t check whether you’ll be able to repay the loan. If you can’t repay the loan, you could be forced to roll the loan over repeatedly, accumulating new fees each time.
- The loan doesn’t help you build credit. If the loan provider doesn’t report to any of the three major credit bureaus (Experian, Equifax or TransUnion), this could be a warning sign. If you’re unsure whether or not a loan reports to the credit bureaus, ask.
Con 3: It’s easy to get trapped in a debt cycle
Each time you extend (rollover) a loan, a payday lender charges additional fees, increasing your out-of-pocket costs for borrowing the money.
In fact, nearly 1 in 4 payday loans are borrowed more than 9 times.
Rolling the loan over can significantly increase the amount of time it takes to repay the loan, sometimes adding months or years to the original two week terms.
Con 4: They target low-income, minority communities
According to a 2016 report by the Center for Responsible Lending, payday lenders are mostly located in minority communities. In fact, the report found, there are about 8.1 payday loan stores per 100,000 people in African American and Latino communities, while mostly white neighborhoods only had about 4 for every 100,000 people.
That means there are twice as many payday lenders in communities of color as there are in white communities.
According to Keith Corbett, Executive Vice President of the Center for Responsible Lending, payday lending in communities of color is comparable to Jim Crow laws. In an NPR interview Corbett states that in the Jim Crow era, everyone said it was a free market, so it was “okay” for people of a certain color to have to ride in the back of the bus.
“The argument to place these fringe financial services in our community is pretty much the same. And think about it. If you are in a low-income community and the only place you see for financial transactions is a payday lender or a rent-to-own shop, it becomes a normal situation.”
He continues by calling out the financial disparity between white communities and communities of color, citing the large gap in interest rates as a possible cause:
”And so what happens is if one community is paying no more than 15% to borrow money and the other community is paying 300-400% minimum, the community will never get out of poverty,” Corbett states.
Con 5: They have access to your bank account
To gain access to a fast cash advance, borrowers are often required to grant the lender access to their bank account. While setting up direct deposit to make bill and loan payments is pretty common now, this account access works a little differently.
“Some payday lenders attempt to recover their money by taking what they’re owed directly from borrowers’ checking accounts, which borrowers grant access to as a condition of the loan. But unexpected withdrawals from the lender can rack up pricey overdraft fees and damage credit scores,” CNBC reports.
Many payday lenders have you write a postdated check – meaning in this case, a check that is dated to be cashed after your next payday – when you get the loan. If you don’t have enough money in your account when they cash the check, you could face expensive overdraft fees and bounced check fees (also known as insufficient funds) from your bank as well as returned or failed payment fees from the lender.
These extra fees add to the already high costs charged by payday lenders. If you find yourself in this situation, contact your bank immediately to discuss your options for protecting your account.
Con 6: Payday lenders can sue you for the money you owe
Just like other lenders, if you fail to pay a payday lender for long enough, they can take you to court and try to get a judgment against you for failure to repay a debt. If a judgment is ordered, you could face wage garnishment, imprisonment or other consequences.
Keep in mind, however, that legal battles are expensive. In the case of small-dollar loans, it’s not always worth the time and money involved for the lender to sue. However, some companies or debt collectors will threaten to sue or threaten wage garnishment to scare you into paying them back quickly.
If you receive these threats, consider getting help from a local nonprofit organization focused on debt management, an Accredited Financial Counselor or a Certified Credit Counselor who could help you with your unique needs.
Con 7: They don’t help you build credit
Last but not least, payday loans do not help you build credit because they do not generally report to the credit bureaus.
Some versions of payday loans in some states allow you to work your way up to lower interest loans that can be paid in installments and that report to the credit bureaus. However, this option is rare and little information is available on how long it takes, or how many unreported loans at high interest rates are required before you’re able to build credit with their loan.
Similar to medical debt, payday loans usually only report your debt to the credit bureaus if it gets sent to collections. So while payday loans can’t help you build credit, they could hurt your credit if you’re not careful.
If you build good credit, you could qualify for higher quality financial products, including personal loans and credit cards with lower interest rates.