Payday Loans And Other Lending Traps Personal Finance

Can’t Wait Until Payday? You need $300! How are you going to get it? There are many ways to obtain cash if a person needs money before payday

Ways to get a Loan Credit card Payday loan Auto title loan Pawn shops Loan from your financial institution Loan from parents or other family/friends

What Are Some Other (Legal)Ways To Get Money?

Short term loan providing immediate cash. Also known as: PayDay Loans Short term loan providing immediate cash. Also known as: Cash advance loans Check advance loans Post-dated check loans Deferred deposit check loans

Payday lending locations Check cashers Payday loan stores Pawn shops Toll-free numbers Rent-to-own companies Internet Required to give the lender access to financial accounts and social security number Increases the risk of fraud and identity theft

How to receive a payday loan Who uses payday loans? Users typically have poor credit history Users cannot obtain a traditional loan Requirements to receive a payday loan Have a bank account Proof of income Personal identification

Why Use Check Cashers? Focus groups of low-income and ethnic consumers identified five ways check cashers were superior to banks Easier access to immediate cash More accessible locations Better service Shorter lines, more tellers, more targeted product mix in a single location, convenient operating hours, and Spanish-speaking tellers More respectful, courteous treatment of customers Greater trustworthiness

Obtaining a payday loan Personal check Individual writes a check to the lender for the amount borrowed and the lending company fee Payday loans are issued for amounts between $50 and $1000 Payday loan fees are between $10 and $30 per $100 borrowed Fees translate to an APR of 391% - 443%!!

Example of a Payday Loan Example: If James needs $100, he will be charged $15 in fees. He will write a check for $115 and receive $100. Lender will hold the check until the agreed upon date (usually the borrower’s payday) before cashing it

Obtaining a payday loan Automatic withdrawal Borrower gives lender permission to automatically withdraw the funds from their financial institution account on the date of the check

Payday Lending Options Payday loans are difficult to pay back Payday lending companies may require borrowers to pay back the entire loan in one lump sum rather than installments For example: if Max saves $25 each pay period, he cannot apply that money to a payday loan until it equals the total cost of the loan

Other credit options, such as a credit card or loans do allow installment payments For example: if Max saves $25 each pay period, he can apply that money to a credit card balance 91% of all payday loans are made to borrowers with five or more payday loans per year (Center for Responsible Lending, 2004)

Payday Lending Options If lenders cannot pay back their payday loan in full on their pay day, there are three options (on the next slides)

Option 1-Rollover or Extension Pay another fee for the original loan Example: If James does not have enough money to pay back his $100 loan, he may pay $15 to extend the loan until his next payday Cost of the loan after one payday Original loan = $100 + $15 = $115 Rollover fees = $15 Total cost of the payday loan = $130

Option 2-Back to Back Pay back the original loan, but immediately take out a new loan to cover expenses Example: If James can pay back the original loan on his payday, but then needs money to pay other bills, he can take out another loan. Cost of the loan after one payday Original loan = $100 + $15 = $115 Payback $100 on payday New loan = $100 + $15 = $115 Total cost of the both payday loans = $130

Option 3-Default If an individual does not have enough money in his checking account, the borrower will default on the loan Insufficient funds (NSF) fees are charged by the lender and financial institution NSF fees may be charged multiple times if insufficient funds remain in the account

Example of a Default Example: James wrote a check for a payday loan. He does not have enough money in his checking account to cover the loan amount on payday. Cost of the loan after one payday Original loan = $100 + $15 = $115 Payday lender NSF fees = $20 Financial institution NSF fees = $20 Total cost of the payday loan = $155

Risks of payday lending Borrowers can get “trapped” in a cycle of borrowing Lead to long term debt and legal problems Payday loan customers are 4 times more likely than all adults to file for bankruptcy (Stegman & Faris, 2003)

Trends in payday lending Ten years ago Payday lending was virtually non-existent (Center for Responsible Lending, 2004) By the end of 2005 Payday loans amounted to $40 billion (Consumer Federation of America) Fees paid by borrowers were $6 billion (Consumer Federation of America)

The PayDay Loan Industry Payday loan industry today: Is thriving because people pay the fees without seeking alternative forms of credit Today there are more payday loan stores than McDonalds and Burger King restaurants in California

Government Regulation Some states have small loan laws making payday lending illegal or regulating the number of times a rollover can occur The Truth in Lending Act Requires payday loan companies to advertise the finance charges and annual percentage rate All terms must be in writing for customers

Interest rates are usually about 25% a month (300% APR) Auto Title Loans Your car title is the security for a short-term loan (usually less than 30 days) If you don’t pay the loan back, they can take your car Interest rates are usually about 25% a month (300% APR) The loan will be rolled over at the end of the month, if you pay the interest More interest is added each month

Item—Microwave with a cash purchase price of $399 Sample of Rent-to-Own Item—Microwave with a cash purchase price of $399 Rent-to-own will charge you $7.99 a week for 78 weeks (18 months) Total price paid for microwave: $623 Interest=$284 APR=about 40%

Pawn Shops You receive a loan on something you own (collateral) If you don’t repay the loan, the pawnbroker can sell the item You can extend the loan from month to month by paying the monthly interest fees Usually you don’t get very much for your item APR can be as high as 300%

Alternatives to Lending “Traps” Family or friends May charge much lower finance fees Paycheck advance Ask employers to issue a paycheck earlier if bills are due Overdraft protection May be less costly than paying payday lending fees

Ask creditors for more time to pay bills Other Alternatives Ask creditors for more time to pay bills Make arrangements to pay bills after receiving a paycheck Financial institution loan for large amounts Interest rates may range from 10% to 18% Credit card Higher interest rate of 16% to 21% Is still lower than the ~400% interest rate of a pay day loan

Create a spending plan Open a savings account Other Alternatives Track income and expenses Open a savings account Set aside money from each paycheck Emergencies Unexpected expenses

Quotes of the Day If you learn to spend less than you earn, then you will have the freedom and the money to reach your dreams in life Those who understand interest EARN it. Those who don’t understand interest PAY it.

Interest buys you nothing Remember... If you buy something on sale with credit and cannot pay it off that month, it was not on sale Interest buys you nothing