Payday Loans Exposed: The Truth Lenders Don't Want You to Discover

Last Updated: February 23, 2024

Secret Dangers of Payday Loans Lenders Hide

Disclaimer: We are not qualified legal or tax professionals and are not giving advice. Always speak with a qualified professional before making any legal or financial decisions.

Payday loans seem like an easy fix when you need cash quickly. The lenders promise fast money without asking too many questions. Just show up with a pay stub, valid ID, and a checking account, and you can walk out with hundreds of dollars in minutes. What could be simpler?

However, what payday lenders often don't disclose is that the convenience comes at an incredibly high cost. The interest rates and fees associated with payday loans are astronomical compared to other options. And the short repayment terms make it very likely you'll get caught in a vicious debt cycle.

In this comprehensive guide, we'll uncover the truth about payday loans that lenders try to hide. You'll learn how their business model depends on keeping borrowers trapped in debt. We'll explain the massive fees you can end up paying and how the loans create a downward spiral that is extremely difficult to escape.

Considering alternatives like debt consolidation loans can be a smarter financial move. For those looking to understand the risks and find safer options, the Consumer Financial Protection Bureau (CFPB) offers valuable insights and resources on managing and avoiding payday loan debt.

What Are Payday Loans?

Payday loans are a type of short-term, high-cost borrowing of money where a financial institution or a third bank or lender provides a small cash advance that must be repaid quickly.

Here are some key facts about how payday loans work:

• Loan amounts are typically small- Most payday loans range from the first loan approval amount with payments of $100 to a loan approval of $1,000. The average first loan amount and size is around $375.
  
• Terms are very short- Most payday loans have term lengths with a 2-week term, coinciding with the auto loan borrower's next payday. Some loans have term lengths with terms from 1 to 4 weeks.
  
• Extremely high-interest rates- Payday lenders charge an interest rate somewhere between 390-780% APR on the loan closing the cash advance.
  
• All online or in-storefronts- Payday loans are available from online lenders and at over 20,000 store locations across the US.
  
• Fast access to cash- Borrowers can walk out with cash in hand or get funds deposited into their bank account within 24 hours.
  
• Few requirements to qualify- Typically all that is required is ID, proof of income, and a bank account. No intensive credit check is done or credit approval, in most cases. To get a payday loan, the borrower writes a postdated check for the maximum loan amount, or minimum and maximum loan amount due, plus fees that the lender can cash on the maturity date.
  

Some lenders allow other forms of access to the money in the borrower's bank account as opposed to a check. The quick access to cash is tempting for many consumers facing a financial crunch. But as we'll explore next, the convenience comes at an extremely high cost.

The Hidden Costs of Payday Loans

While payday loans provide fast cash, they come with high hidden costs that keep borrowers trapped in debt, and loans can wind up costing much more than expected. Here are some of the ways payday:

• Astronomical interest rates- Payday loan APRs typically range from 390-780%. That means for a $500 loan, you could pay over $1,000 in interest alone after just three monthly payments for one year. Compare that to credit cards averaging 15-30% APR.
  
• Rollover fees- The short 2-week down payment terms make these secured loans very difficult to pay off. Most borrowers have to roll over the loan and take out a new loan to cover the old one. Each renewal of secured loans has new fees attached to existing debt.
  
• Origination fees- Payday lenders charge origination fees of up to $30 for each new loan. Those fees get charged every time the loan is rolled over.
  
• NSF fees- If the lender attempts to cash the check or the borrower receives the full loan amount and proceeds to debit the account on the due date and there are insufficient funds, the loan proceeds or the borrower is charged an NSF fee of $15-$35.
  
• Bank overdraft fees- Even if the monthly payment amount doesn't bounce, just having the lender withdraw the monthly payment amount from the prepaid card account can overdraw the other savings account, or checking account and trigger overdraft fees of $30-35 per transaction.
  
• Debt Spiral- The weight of paying the loan fees leads many borrowers to take out new personal loans and fall deeper into debt. 80% of payday loans go to repeat borrowers within a month.
  

As you can see, a simple $500 payday loan can potentially spiral into thousands in fees very quickly. Now you understand why payday lenders depend on keeping borrowers trapped in an ongoing debt cycle!

Predatory Lending Tactics in Payday Loans

Payday lenders engage in a number of predatory tactics to take advantage of borrowers' financial desperation and lack of understanding of the true loan costs. Here are some of the ways lenders benefit at the expense of consumers:

• Targeting low-income and minority communities- Payday lender storefronts are disproportionately located in minority, elderly, and low-income neighborhoods.
  
• Masking the true loan costs- APRs are downplayed and origination fees are only disclosed in the fine print. This obscures the true costs.
  
• Providing loans borrowers can't afford- Lenders do minimal checks on the credit report and the ability to repay. Income on credit reports is not verified in many cases.
  
• Pushing repeat rollovers- Collections staff will call borrowers before payment is due and offer an easy rollover. No mention of other options.
  
• Obtaining access to bank accounts- Mandating postdated checks or electronic access provides a way to extract monthly payments and fees.
  
• Aggressive collections- Harassing phone calls, lawsuits, and even threats of criminal prosecution are used against delinquent borrowers.
  
• Lobbying against regulation- Payday lenders have spent millions to lobby for favorable laws and prevent rate caps.
  

Many of these tactics are clearly designed to benefit the lender's bottom line while disregarding ethics. The business model depends on keeping borrowers trapped in an ongoing cycle of high-interest debt they can never repay.

Payday Loans vs. Other Bad Credit Options

When facing an emergency expense with poor credit, payday loans may seem like your only option. But there are other types of bad credit loans and options to consider that may be less predatory.

• Pawn Shop Loans- These require you to offer up something of value as collateral, like jewelry or electronics. You get a loan for a fraction of the item's value. Less risky than a payday loan offers more loans but you can lose collateral.
  
• Auto Title Loans- Your car title is put up as collateral for an emergency cash loan. Very high interest rates and you risk losing your vehicle.
  
• Credit Card Cash Advances- If approved, you can pay and withdraw cash on your credit card or pay at an ATM. Much lower interest rates but can hurt your credit score and utilization. Click here to learn more about paying loans with credit cards.
  
• Bank Personal Loans- Some banks offer personal loans or loans for bad credit. Rates on personal loans are higher but more transparent loan terms than payday lending.
  
• Borrowing from Family/Friends- Asking relatives for a personal loan can be uncomfortable but avoids predatory lending. Draw up a personal or loan agreement, only agreement with a repayment agreement.
  
• 401k/Retirement Account Loans- Allows you to borrow against yourself and pay back into a prepaid excellent credit card account or your retirement savings or checking account afterward. Doesn't help your credit score, but very low rates.
  
• Credit Union Payday Alternative Loans- Offered by some CUs and comes with lower rates, longer loan terms sometimes, and financial counseling. While each option carries risks and disadvantages, they are likely to be less damaging than getting caught in the payday loan debt trap. Do your research to find the alternative that best fits your situation.

The Vicious Debt Cycle of Payday Loans

One of the biggest dangers of payday loans is how easily they can lead borrowers into a vicious debt cycle.

Here is how it typically plays out:

• The borrower takes out a small $500 payday loan when short on cash before payday.
• Two weeks later when the loan is due, they still don't have the $575 needed to repay it.
• The lender offers to roll it over into a new loan and extract the interest payment of $75.
• This continues every two weeks with the lender withdrawing $75 in interest before any principal is paid.
• To cover living expenses, the borrower takes out more payday loans with other lenders.
• Soon they have multiple loans they are constantly rolling over and renewing every two weeks.
• 50% or more of their paycheck goes just to paying interest fees alone.
• They may need to overdraft their bank account just to afford the interest payments.
• Eventually, they default on the loans entirely and the process repeats.

This cycle can go on for months or even years. The Consumer Financial Protection Bureau found that 80% of payday loans go to borrowers stuck in this type of debt trap, taking out multiple loans over 6+ months. This is how lenders can continue extracting monthly payments and hundreds in fees from the same desperate borrowers.

Who Really Benefits from Payday Loans?

Given their predatory lending practices and exorbitant fees, it should come as no surprise that payday loan companies are extremely profitable.

Let's look at who really benefits from this model:

• Payday lenders- The industry rakes in $9 billion in loan fees each year according to Pew Charitable Trusts. Default losses are minimized through access to borrower accounts.
  
• Wall Street Investors- Publicly traded payday lending companies return billions to shareholders through dividends and stock buybacks.
  
• The Banks- Major banks provide the financing and credit lines that payday lenders depend on for their cash advances. They earn interest on this lending.
  
• Debt collectors- Defaulted payday loan debt is turned over by multiple lenders to collections agencies. They aggressively pursue the debts and take a cut.
  

And who loses out:

• The Borrowers- Low-income borrowers pay the majority of the $9 billion in fees and high interest rates while ruining their credit.
  
• Minority communities- African-American and Hispanic neighborhoods are disproportionately targeted by payday lenders.
  
• Consumer spending- The money extracted from payday fees doesn't go back into the general economy to save money.
  

Understanding who gains sheds light on why the industry fights so hard against regulation. The business model is simply too lucrative to give up easily.

Federal Regulation of Payday Loans

To protect borrowers against predatory lending, the federal government has enacted some regulations around payday loans.

• Truth in Lending Act (TILA)- Requires lenders to disclose APR, finance charges, and total repayment and loan amounts due.
  
• Military Lending Act- Caps interest on loans to military personnel at 36%.
  
• CFPB Payday Lending Rules- Required underwriting standards to ensure affordability. Revoked in 2020.
  
• Proposed federal legislation- Bills introduced in Congress propose national interest rate caps of 36% but have not passed.
  

However, regulation has been limited at the federal level. Under the Trump administration, the Consumer Financial Protection Bureau reversed key rules around verifying borrowers' ability to repay.

Many advocates argue that national rate caps are needed to prevent predatory lending. So for now, regulations are primarily happening at the state level:

• 18 states ban payday loans outright.
• In other states, interest rate caps vary widely from 17% to 667% APR.
• Only 6 states have effectively capped rates at or below 36%.

More federal laws and regulations could establish nationwide safeguards against predatory practices. But for now, protection varies significantly depending on where you live.

Avoiding the Payday Loan Debt Trap

The best protection against predatory payday lending is avoiding the loans altogether. Here are some tips to stay away from debt traps.

• Build an emergency fund- Having 3-6 months of expenses saved gives a buffer for emergencies without needing payday loans.
  
• Ask for an advance- Some employers will give one-time wage advances to help with temporary cash crunches.
  
• Lower expenses- Review your budget and cut any non-essentials like subscriptions you can. Trim expenses where possible to save you more money.
  
• Consider alternatives- Explore options like local charities, personal loans, from family or friends, and credit union loans.
  
• Improve your credit- Building your credit over time opens up more affordable lending options for when funds are needed.
  
• Contact your state regulator- Reach out to your state attorney general's office to understand your rights around payday lending.
  
• Support more regulation- Get involved with advocacy groups pushing for stronger consumer protections at both the state and federal levels.
  

With some planning and smart money management, viable alternatives to costly payday loans do exist. The most important step is recognizing the risks going in, so you can make the best informed decision for your situation.

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