“Need cash now? We can help!”
“$100 – $1,000 approved in just 2 minutes!”
“No credit? No problem!”
We all hear those commercials. They’re everywhere. On TV. On the radio. Online. You can’t escape them. Apparently these people really want to give you cash. And they want you to get it fast! But chances are, unless you’ve been in bad enough financial shape to need one of these loans, you might not know what they are, how they work, or how dangerous they can be.
Loans like the ones in these advertisements are called payday loans. A payday loan is a small consumer loan, usually for under $500, which uses your paycheck as collateral. They’re not offered by traditional banks or credit unions, but rather by Check Cashing Agencies or PayDay Lending Companies.
Here’s how it works. Say you need $400 to pay to get your car fixed. You don’t get paid for another week, you don’t have any money saved, you’ve maxed out your credit cards, and you know your credit is terrible. So you go to a payday lending company and apply for a loan for $400. They won’t check your credit. They won’t ask for references. All they need is your basic contact information, proof of employment, and your checking account number. Then, you write them a check for the $400 plus a loan fee, which is typically around $15 per $100 loaned. In this case, you would write the payday lender a check for $460. They hold on to that check as collateral and then give you $400 in cash. When you get your next paycheck, you use it to pay them back the $400 plus the $60 fee. Or at least that’s what’s supposed to happen . . .
The thing is, most people who use payday loans are doing it as a last resort. Fast cash won’t solve their financial problems, it will just get them through the next few days or the next few bills. That $400 might have paid to fix their car or for groceries for the week, but 2 weeks later they have more bills to pay. Now they need money to put gas in their tank. They need to pay the electric bill. They need to fill a prescription. Basically, they need that paycheck for new expenses when they’ve already spent it on old ones and suddenly they’re right back where they started before they got the loan.
So the payday lender gives them two options. Option 1: pay back the loan in full and end the transaction. Option 2: pay a small fee to extend the loan for another 2 weeks. In our example, that’s a choice been paying the lender $460 today or just $60. To a lot of the customers using this kind of loan, that’s not a choice at all. They need the $400 for other bills. So they pay to extend the loan instead. The paycheck after that isn’t enough to pay for bills and repay the loan either, so they extend the loan again. Unless they get a new job or a major expense magically disappears, they will never have enough money to pay off the loan completely so they just get caught in a cycle of endlessly paying the extension fee over and over again.
Why the P.S.A. about the dangers of payday lending, you ask? Because the biggest misconception about payday loans is that only people who regularly struggle with money need them. You might be reading this post from the comfort of your office at your well-paying job. If so, you’re probably thinking that you wouldn’t ever be so strapped for cash that you would actually respond to those cheesy commercials offering “$500 in just 5 minutes!” But the truth is, a growing majority of payday borrowers are middle class. They were financially stable adults, until one or two things went wrong and threw their financial world into turmoil. As Jonathan Mintz, CEO of the Cities for Financial Empowerment Fund put it, “The picture of the financially unstable is the picture of you and me but for a couple of breaks.” Often people fall into the payday lending trap because like me, they ignored those ads. They didn’t know what payday lending was or how financially harmful it could be, so when they suddenly became strapped for cash the product payday lenders pedal seems appealing, even life-saving.
The good news is, there are alternatives to payday loans available. Many credit unions and small banks offer short-term “emergency” loans, that provide a small amount of cash to a borrower based on their income. For example, here at Casco FCU we offer a Safety Net Loan. Members can borrow up to $1,000 for 6 months. Like a payday loan, your credit score doesn’t matter, approval is based on proof of employment. Unlike a payday loan, however, a Safety Net Loan is repaid in fixed monthly installments over a short period of time. Making payments also allows you to build a relationship with a reputable financial institution and to improve your credit score so you increase your access to traditional loans in the future. And perhaps most importantly, a loan officer will help you go over your monthly budget and give you advice on how to better manage your bills; the Safety Net Loan isn’t just a temporary fix like a payday loan, it’s a solution to help you build a better financial future.
Long story short – stay away from payday loans! They’re never a good idea.