The truth about payday loans: very high interest
Consumer advocates call it a debt trap
Many Americans are increasingly turning to high-interest, short-term loans to try to make ends meet, but a brief overview of payday lending’s problematic setup shows that it’s often a false solution to a false problem.
Payday lenders claim to be a convenient source of credit for low- to moderate-income families in a budget crisis. Yet a revealing study from Pew Research shows that contrary to common assumptions, borrowers typically use payday loans to pay for day-to-day expenses, not emergencies.
Payday loan centers tend to concentrate in minority neighborhoods underserved by mainstream banks, capitalizing on economic vulnerabilities brought on by decades of discriminatory legislation, financial deregulation and a decline in savings. Lower-income workers use payday loans to try to reconcile their stagnant wages with the rising cost of living, only to find that they’ve added another bill to their budget.
With little or no savings, borrowers struggle to pay off the loan balance on time amid sky-high predatory interest rates, leading them into what consumer advocates call the debt trap.
Payday lenders regularly mislead their customers by advertising their fees as a dollar amount rather than an APR, or annual percentage rate. Paying a $50 fee for a loan of $500 over a period of two weeks may not seem that bad at first glance, but that fee overlooks the fact that borrowers take an average of five to eight months to pay back their loans. If you calculate the loan’s APR, or what that loan would cost over the course of a year, the true interest rate balloons to a level far beyond that of most credit cards and bank loans—a whopping 260 percent. Doing the math is essential to avoid ruinous setups offered by lenders such as Western Sky, which offers a $5,075 loan that can lead to an appalling $40,872 in repayment.
One of the worst ironies of the nagging economic recession is that consumers with the fewest financial resources have lost the most.
Now, a new report finds that payday loans not only strip much-needed income from low-income families but also harm the economic viability of the communities where they operate, draining nearly $1 billion a year.