Payday loans, also known as cash advances, are short-term loans that are marketed as a quick solution to a financial emergency. The loans are typically offered by storefront lenders in low-income areas and online, and they are available to borrowers with poor credit or no credit history. While payday loans can be helpful in some situations, they have come under fire for their high interest rates and predatory lending practices that trap borrowers in cycles of debt.
The basic premise of a payday loan is that a borrower can get quick access to cash by borrowing against their next paycheck. The borrower writes a post-dated check for the loan amount plus fees, which the lender will cash on the borrower's next payday. If the borrower is unable to repay the loan on time, they can either roll over the loan by paying additional fees or take out a new loan to pay off the old one.
According to a report by the Consumer Financial Protection Bureau, the average payday loan amount in 2020 was $375. The average repayment period was two weeks, and the average annual percentage rate (APR) for a payday loan was 391%. For context, the average credit card APR is around 16%.
The high interest rates and short repayment period of payday loans can create a cycle of debt that is difficult to break. Borrowers who are unable to repay their loans on time often end up taking out new loans to cover the old ones, racking up more fees and interest charges.
Payday lenders have also been known to engage in other predatory lending practices, such as:
Payday loans can have a significant impact on borrowers' financial health. According to a study by the Pew Charitable Trusts, 12 million Americans take out payday loans each year at an average cost of $520 in fees and interest charges. The same study found that the majority of borrowers rely on payday loans to cover basic expenses such as rent and groceries, rather than unexpected emergencies.
Furthermore, payday loans can have ripple effects on borrowers' credit scores and overall financial well-being. Late or missed payments can result in collections calls, legal action, and damage to credit scores. In some cases, borrowers may even lose their bank accounts or be forced to declare bankruptcy.
There are several alternatives to payday loans that can provide borrowers with quick access to cash without the high fees and interest rates. Some options include:
While payday loans can provide a quick fix to a financial emergency, they should be used with caution. The high interest rates, short repayment periods, and predatory lending practices associated with payday loans can create a cycle of debt that is difficult to escape. Borrowers should explore alternative options before taking out a payday loan and be sure to read the fine print before signing on the dotted line.