Understand payday loans risks and lending alternative

Payday loans also called “cash advance loans” – appear to offer a way out. You can walk into one of the thousands of payday lending offices across the country and walk out half an hour later with $300 in your hand to pay that repair bill.

Then, on your next payday, you can come back in to repay that $300 – plus another $45 or so in interest.

The problem is, if you had a hard time raising $300 in the first place, losing $345 out of one paycheck leaves a big hole in the budget. And so before the month is out, you could find yourself coming back for another loan to cover the bills you can no longer afford to pay.

Before long, you end up entrapped in an ongoing cycle of debt, going from loan to loan, while the interest payments pile up higher and higher. A 2012 report from the Pew Charitable Trusts found that the typical payday borrower takes out eight $375 loans per year, paying a total of $520 in interest.

Many borrowers can’t break free of this cycle without taking extreme measures. They slash their budgets, borrow from friends and family, pawn their belongings, or take out a different type of loan. These are all steps they could have taken to avoid getting the payday loan in the first place, saving themselves all that interest.

So if you want to avoid the payday loan trap, you should make sure you’ve looked at all their other options first. Even when you absolutely need some extra cash to make it through the month, there’s almost always a better way of getting it than turning to a payday loan shark.

Payday loans get their name because they usually come due on the borrower’s next payday. They’re different from regular bank loans in several ways:

Smaller Amounts. In most states where payday loans are legal, there’s a limit on how much you can borrow this way. This cap ranges from $300 to $1,000, with $500 being the most common amount. The Pew report says the average size of a payday loan is $375.

Shorter Terms. A payday loan is supposed to be paid back when you get your next paycheck. In most cases, this means the loan term is two weeks, though it can sometimes be as long as a month.

No Installments. With a normal bank loan, you pay back the money bit by bit, in installments. For instance, if you borrow $1,000 for one year at 5%, you pay back $85.61 each month – $2.28 for the interest and the rest for the principal. But with a payday loan, you have to pay back the whole sum – interest and principal – all at once. For a borrower on a tight budget, this is often impossible.

High Interest. When you borrow money from a bank, the interest you pay depends on your credit rating and the type of loan you’re getting. A borrower with excellent credit can get a mortgage loan with an annual percentage rate (APR) of 3% or less. By contrast, someone with bad credit taking out an unsecured personal loan would pay 25% or more. But payday loans charge all borrowers the same rate – usually around $15 per $100 borrowed. So, for instance, if you borrow $500, you pay $75 in interest. That doesn’t sound so bad until you remember that the loan term is only two weeks. On a yearly basis, it works out to an APR of 391%.

No Credit Check. Banks check your credit before giving you a loan to figure out how much to charge you. If your credit is really poor, you probably can’t get a loan at all. But you don’t need good credit – or any credit – to get a payday loan. All you need is a bank account, proof of income (such as a pay stub), and an ID that shows you’re at least 18 years old. You can walk out with your money in less than an hour – a major reason these loans appeal to financially desperate people.
Automatic Repayment. When you take out a payday loan, you hand over a signed check or other document that gives the lender permission to take money out of your bank account. If you don’t show up to repay your loan as scheduled, the lender either cashes the check or withdraws the money from your account.

Easy Renewals. If you know you can’t afford to pay off your loan on time, you can come in before it comes due and renew it. You pay a fee equal to the interest you owe and give yourself another two weeks to pay back your loan – with another interest payment. Or, in states where that’s not allowed, you can immediately take out a second loan to cover what you owe on the first one. That’s how so many users end up taking months to pay what started out as a two-week loan.

Payday lenders often market their products as short-term fixes for emergency needs, such as car repairs or medical bills. But according to the Pew survey, most users don’t use them that way. Nearly 70% of first-time borrowers say they took out their loans to help pay for basic needs, such as rent, food, utilities, or credit card bills. Only 16% say they borrowed the money for an unplanned, one-time expense.

When Pew asked people what they would do if they couldn’t use payday loans, they gave a variety of answers. More than 80% said they would cut back on basic expenses, such as food and clothing. More than half also said they would pawn something or borrow from friends and family. However, most users did not say they would use credit cards or take out bank loans – possibly because many don’t have good enough credit to qualify.

In June 2016, the Consumer Finance Protection Bureau proposed a new rule to regulate payday lending at the national level. This rule would require lenders to check borrowers’ income, expenses, and other debts to make sure they can afford to pay back the loan. It would also limit the number of loans a borrower can take out consecutively, helping to break the cycle of debt. And finally, it would require lenders to let borrowers know before pulling money out of their bank accounts and limit the number of times they can try to withdraw money before giving up.

This rule hasn’t taken effect yet, and many payday lenders are hoping it never will. The CFSA released a statement claiming this rule would force payday lenders out of business. This, in turn, would “cut off access to credit for millions of Americans.”

However, Pew argues that there are ways to change the rules that make it easier for low-income Americans to get the credit they need. The problem is, the proposed rule doesn’t do that. Instead, Pew says, it would let payday lenders keep charging triple-digit interest rates while making it harder for banks to offer better, cheaper alternatives. Pew has proposed its own rule that would restrict short-term loans, but would encourage longer-term loans that are easier to repay.

To get around the restrictions on payday lending, some lenders offer auto title loans instead. However, this so-called alternative – which is illegal in about half the states in the country – is really just a payday loan in disguise.

When you take out an auto title loan, the lender examines your car and offers you a loan based on its value. Typically, you can get up to 40% of the car’s value in cash, with $1,000 being the average amount. Then you hand over the title to the car as collateral for the loan.

Car title loans have the same short terms and high interest as payday loans. Some are due in a lump sum after 30 days, while others get paid in installments over three to six months. Along with interest of 259% or more, these loans also include fees of up to 25%, which are due with your last payment.

If you can’t make this payment, you can renew the loan, just like a payday loan. In fact, the vast majority of these loans are renewals. Pew reports that a typical title loan is renewed eight times before the borrower can pay it off. So just like payday loans, auto title loans trap their users in a cycle of debt.

However, if you can’t afford to pay the loan or renew it, the lender seizes your car. Many lenders make you turn over a key or install a GPS tracker to make it easier for them to get their hands on the vehicle. Some of them even store the car while they’re waiting to sell it – and charge you a fee for the storage. And if the amount they get when they sell the car is more than what you owe them, they don’t always have to pay you the difference.

It’s easy to argue that payday loans and auto title loans are just plain evil and should be banned completely. But the problem is, there’s a demand for them. A Pew survey finds that most payday loan users say these loans take advantage of them – but at the same time, most say the loans provide much-needed relief.

Fortunately, there are better ways to raise cash in a crisis. Sometimes, it’s possible to get by without borrowing money at all. You can sell off belongings or ask for an advance on your paycheck. You can also apply for emergency aid, such as Medicaid or SNAP (food stamps), or seek help with paying off other debts.

But even if you need to borrow money, there are better places to turn than a payday loan office. In many cases, friends and family can help you out with a loan. Pawn shops and many online lenders offer small loans, even to people with bad credit.

Finally, if you have a credit card, a retirement fund, a life insurance policy, or even a bank account, you can tap into it as a source of emergency cash. These options are costly, but in the long run, they’re better than being trapped in payday loan debt.