The Ugly Truth of Pay-Day Loans

Photo by Steve Rhodes

In the ever shrinking credit market, it's become more and more difficult for low-income consumers to obtain traditional forms of credit, such as credit cards and personal loans. As a result, more people have turned to “pay-day loans.”

These short-term loans allow consumers to almost instantly obtain cash, using uncashed checks or electronic access to a bank account as collateral.  

Most pay-day loans require repayment within a week or two, usually when the borrower receives their next pay check. The problem is that borrowers who can ill afford to do so must re-pay not only the amount of the loan but a hefty finance charge. Those who can't pay back the entire loan within the specified period,are charged additional fees until the loan is paid off in its entirety.

Pay-day-loan firms typically charge over 300 percent APR (Annual Percentage Rate), although many loaners usually advertise at a better rate. Add this interest to the balance of the loan and you might as well borrow from a loan shark. The only advantage of a pay-day loan is that Guido won't show up to break your legs when you can't pay. 

Thanks to the recession, pay-day loans have become big business. Here are some basic facts you should consider before taking out a pay-day loan.

1. Loan Terms and Fees
Typical loan terms range from as little as $100 to upwards of $2,000 dollars. State laws determine the size and terms of loans, but companies can charge additional fees above the interest rate. For example, a borrower often may end up paying $115 on a $100 loan; an interest rate of well over 600 percent. 

2. Target Audience
Most pay-day-loan customers are extremely poor with no credit. They need cash immediately and don't have any other way of raising it. It would be much cheaper, in the long run, to take a cash advance on a credit card than borrowing from a pay-day vendor, but most don't have access to credit cards. 

3. Required Terms
To take out a pay-day loan, all a borrower needs is a bank account and proof of income (usually a paycheck). Lenders don't inquire about the borrower's ability to pay back the loan, as they prefer the loan to continue accruing fees and interest. 

4. Lenders
Pawn shops, check-cashing companies and loan stores all can make pay-day loans. There are approximately 20,000 to 25,000 pay-day locations spread throughout the United States with an approximate $25 and $30 billion worth of loans being made each year. Most can be found in poorer locations but this industry has now spread to the Internet, garnering another $7 billion of loans in 2008. 

5. State Regulation
Laws governing pay-day loans vary from state to state. Thirty-five states allow pay-day loans while 15 states have restrictions on how much these firms can charge in fees and interest rates. Other states have instituted rate caps.

6. Opposition
Pay-day-loan opponents believe these firms pray on the poor who will fall hopelessly in debt when they can't immediately pay back their loan. However, the industry insists they must charge these high fees to cover those who default on loans.

7. Popularity
Pay-day loans often are the most simple, low-balance loans available to many with no or poor credit ratings. These loans can be processed immediately with a minimum of paperwork, so the borrower has cash in hand the same day they apply. Often, they are the final option for many at their ropes end. Unfortunately, the predatory practices of this industry only makes things worse for many.