Payday Loans - A Terrible Deal

Most towns have a number of small shops that offer what are known as payday loans. These stores are usually found in strip malls and sometimes, depending on the laws of the state, they double as pawn shops. Their business model is a simple one - the lend money to people who need a little cash to tide them over until their next paycheck. The system is convenient and easy to use; you walk in, show some identification, and write a postdated check for the amount you wish to borrow plus interest.

On your following payday, the business cashes the check you have written and your loan is paid in full.

This seems like a great idea - helping people get to their next paycheck by lending them a few dollars in the meantime. What’s the problem? The problem is that few people realize just how expensive it can be to borrow money in this manner. The interest rates charged by these companies are often astonishing, and can reach the equivalent of more than 400% per year!

The interest rates that payday loan stores are permitted to charge vary from state to state, but a typical rate for a two-week loan would be 15-17%. That doesn’t seem like much if you are borrowing $100 and writing a check for $115; but the annual interest rate on such a loan is actually 390%, which makes it perhaps the most expensive way to borrow money. The joke in the industry is that it would actually be cheaper to borrow from a loan shark than from one of these legitimate businesses.

The lenders defend these rates, pointing out that such costs are necessary to protect their business overhead and high default rate. That may be true, but many borrowers are blue collar workers who live from paycheck to paycheck. It is easy to fall into the trap of repeatedly using such loans, and the interest adds up in a hurry, tuning a convenience into a nightmare. Someone who is “short” this week may also be short in two weeks, and a loan of a few hundred dollars can quickly turn into a debt of a few thousand dollars, especially when late fees and bounced check fees are added to the total. More than a few borrowers at such businesses have had to resort to personal bankruptcy in order to get out from under their mountain of payday loan debt.

Even more egregious is the fact that such loan stores are frequently located near military bases. Our military personnel aren’t well paid and several members of Congress are not pleased that these predatory businesses are setting up shop for the purpose of exploiting our men and women in uniform. Several states have already passed laws that place limits on the interest rates that such businesses may charge and others will undoubtedly follow. A better alternative for anyone with a short term cash shortage would be to take out a credit card loan or a home equity line of credit instead. There is usually a small fee associated with such a loan, but the interest rates, which are probably no more than 30% , are far more reasonable than the 400% per year charged by the payday lender.

Anyone considering a payday loan should read the terms of the agreement carefully. Otherwise, that short term loan could haunt you for years.