Risks of Payday Loans
Payday lending is marketed as a convenient way for poor Americans with no credit to get small loans, as long as you have a job, a checking account, and a valid form of identification. For every hundred dollars you obtain, you have to pay a $15 fee and take out a 2 week loan. The industry markets these loans as a quick lifesaver when an emergency happens. It’s like an advance on your next paycheck. 7 out of 10 borrowers use payday loans to finance reoccurring expenses like rent, electricity, or to pay down previous payday loans.
How Payday Lenders Make Money
Payday lenders make their money off people that borrow at loan shark rates. The rates are an average of 400% annually. Some rates are as high as 950%. This would mean that someone taking out a $300 loan could end up paying $2,850 in fees alone. So why is this happening? Payday lenders say they need to charge their customers high rates, because there’s a high risk to default. Unlike longer-term loans, borrowers are expected to pay the total amounts they owe within a period of weeks, but 80% of borrowers say they cannot afford to make full lump sum payments. So they roll their balances into new payday loans within the two-week period.
Payday lenders say they do not market their product as a long-term financial solution. This business model encourages borrowers to pay hundreds of dollars in fees, which is not counted as payments towards their loans. This kind of business sparks a cycle of renewed loans, and more debt. This is why 15 states have banned high-cost payday lending. Payday lending is the most predatory lending to the most vulnerable borrowers. Now, if you get rid of these ridiculous regulations it will attract more lenders, and bring down rates.
Now, the government can step in and say you can charge 15%, 20%, or even 30%, but when you get people on a downward spiral where their spending more and more of their paychecks on just interest, it can put a person in a financial crisis. The idea of government intervention can protect people from abusive payday lending methods.
