Payday Loans = Costly Cash

"I just need enough cash to tide me over until payday."
"GET CASH UNTIL PAYDAY! . . . $100 OR MORE . . . FAST."

The ads are on the radio, television, the Internet, even in the mail. They refer to payday loans - which come at a very high price.

Check cashers, finance companies and others are making small, short-term, high-rate loans that go by a variety of names: payday loans, cash advance loans, check advance loans, post-dated check loans or deferred deposit check loans.

Usually, a borrower writes a personal check payable to the lender for the amount he or she wishes to borrow plus a fee. The company gives the borrower the amount of the check minus the fee. Fees charged for payday loans are usually a percentage of the face value of the check or a fee charged per amount borrowed - say, for every $50 or $100 loaned. And, if you extend or "roll-over" the loan - say for another two weeks - you will pay the fees for each extension.

Under the Truth in Lending Act, the cost of payday loans - like other types of credit - must be disclosed. Among other information, you must receive, in writing, the finance charge (a dollar amount) and the annual percentage rate or APR (the cost of credit on a yearly basis).

A cash advance loan secured by a personal check - such as a payday loan - is very expensive credit. Let's say you write a personal check for $115 to borrow $100 for up to 14 days. The check casher or payday lender agrees to hold the check until your next payday. At that time, depending on the particular plan, the lender deposits the check, you redeem the check by paying the $115 in cash, or you roll-over the check by paying a fee to extend the loan for another two weeks. In this example, the cost of the initial loan is a $15 finance charge and 391 percent APR. If you roll-over the loan three times, the finance charge would climb to $60 to borrow $100.

Alternatives to Payday Loans

There are other options. Consider the possibilities before choosing a payday loan:

• When you need credit, shop carefully. Compare offers. Look for the credit offer with the lowest APR - consider a small loan from your credit union or small loan company, an advance on pay from your employer, or a loan from family or friends. A cash advance on a credit card also may be a possibility, but it may have a higher interest rate than your other sources of funds: find out the terms before you decide. Also, a local community-based organization may make small business loans to individuals.
• Compare the APR and the finance charge (which includes loan fees, interest and other types of credit costs) of credit offers to get the lowest cost.
• Ask your creditors for more time to pay your bills. Find out what they will charge for that service - as a late charge, an additional finance charge or a higher interest rate.
• Make a realistic budget, and figure your monthly and daily expenditures. Avoid unnecessary purchases - even small daily items. Their costs add up. Also, build some savings - even small deposits can help - to avoid borrowing for emergencies, unexpected expenses or other items. For example, by putting the amount of the fee that would be paid on a typical $300 payday loan in a savings account for six months, you would have extra dollars available. This can give you a buffer against financial emergencies.
• Find out if you have, or can get, overdraft protection on your checking account. If you are regularly using most or all of the funds in your account and if you make a mistake in your checking (or savings) account ledger or records, overdraft protection can help protect you from further credit problems. Find out the terms of overdraft protection.
• If you need help working out a debt repayment plan with creditors or developing a budget, contact your local consumer credit counseling service. There are non-profit groups in every state that offer credit guidance to consumers. These services are available at little or no cost. Also, check with your employer, credit union or housing authority for no- or low-cost credit counseling programs.

If you decide you must use a payday loan, borrow only as much as you can afford to pay with your next paycheck and still have enough to make it to the next payday.

Source: Federal Trade Commission

MYTH: Rates are high because these loans are risky.

REALITY: High rates are not justified given that the lenders hold a live check and have additional leverage as a result. Aggregate losses of payday lenders are low and returns on investment high. Stand alone payday lenders are generating returns on investments of 35% to 50%.

While many states have criminal bad check laws, they do not apply to a check accepted by the creditor with full knowledge that it was not "good" when written. This fact does not stop payday lenders from filing criminal cases. Other lenders simply deposit the checks after the consumers fail to repay and then proceed under insufficient-funds laws to collect the principal and interest, the regular bounced check fees, triple the check amount as a penalty, and attorney's fees. This practice is not allowed in Indiana under IC 24-4.5-7-409(2).

MYTH: Payday lenders cater to the middle class with an average household income of $35,000.

REALITY: The average household income is more like $25,000 to $30,000, the working poor and those on fixed income. These borrowers are facing an income shortfall or an emergency. Senator Lieberman found that even households with$35,000 in gross annual income will be forced to rollover a payday loan of as little as $168.

MYTH: Payday loans are cheaper than bouncing checks.

REALITY: Average NSF fee charged by banks and thrifts is $17-$18. Payday lenders may tack on additional fees. Total cost may average $40. However, the cost to get one payday loan ranges from $15-$33 per $100 and the average payday loan is at least $200 (cost for this loan is $25-$66). (New Indiana maximum small loan rates are 15% on balances of more than $50 to $100; 10% on amount over $100 for a maximum rate of $35.00) Average customer rolls over several times (10 rollovers per average customer in Indiana). Payday loans fees, on average, greatly exceed NSF fees.

MYTH: Rollovers are rare.

REALITY: Indiana found that the average customer had rolled over 10 times per year for 77% of all customers. If the fee was $30 on a $300 loan rolled over 10 times, the total in fees alone are $300 and the customer still owed the $300. Illinois found an average of 13 contracts per payday loan customer during an average 6-month period. Iowa surveyed the payday loan licensees and found that the average number of loans per year was 12.5.

New Indiana Small Loan statutes require a 25% principal reduction after the first renewed loan. The consumer may renew with the 25% principal reduction up to three times. If there is a balance left after the third principal reduction, the balance is converted to a simple interest consumer loan payable in installments with a maximum annual percentage rate of 36%.

MYTH: It is unfair to extrapolate the fees into an annual percentage rate.

REALITY: That is entirely fair since. Congress, under the Truth In Lending Act, has required the use of the APR for over 30 thirty years, so that consumers can comparison shop. Further, usury caps have always been imposed as a yearly rate from time immemorial.

MYTH: Payday lenders provide a needed service.

REALITY: Price gouging is never a "service." Fast cash and no credit check advertising makes this loan product appear easy and painless.... until the next payday.

MYTH: The payday loan industry is highly regulated so no more regulation is needed. Or "leave us alone" because we will use a voluntary "best practices" standard.

REALITY: The payday loan legislation passed in about 24 states does not "regulate" the industry. For the most part, these statutes were drafted by the industry and are intended to permit this type of lending rather than restrict it. These statutes contain few restrictions that actually protect consumers. The industry's "best practices" are voluntary with no teeth if a lenders does not comply. Moreover, these guidelines fall far short of the protections necessary to prevent the well-documented abuses.

Source: Indiana Department of Financial Institutions