The Predatory Trap Of Payday Loans And Why You Should Avoid Them

A map showing the average payday loan interest rates in different American states, as well as the level of legislative protection against payday loans across the U.S.

Payday loans are marketed as a quick and cheap fix to urgent problems, but underneath that facade lies a whole network of exploitation. This is precisely why, unless it’s a life-or-death emergency, one should never approach companies offering payday loans. Instead, they should rely on their own circle of friends and family, and if that’s not an option, it’s better to sell off unnecessary items for some quick cash or just wait out the problem until the next paycheck arrives.

What Exactly Are Payday Loans?

Payday loans are small, short-term loans designed to cover expenses until your next paycheck arrives. These loans typically range from $100 to $1,500, and they are expected to be paid back relatively quickly, usually within a week or a month, when your next paycheck arrives. For example, let’s say you need $700 to pay off the month’s mortgage payment today, but you only have $50 in your bank account and your paycheck arrives next week. Payday loans make it possible to immediately borrow $700, settle the mortgage payment, and then pay it back to the lender, with interest and fees, once your paycheck arrives the following week.

Payday loans are very easy to get, and lenders usually only require proof of income, a bank account, and identification, and there are no credit checks. The loan and its associated interest and fees will be due in full when the next paycheck arrives.

Why Are Payday Loans Bad?

There is a clear appeal to payday loans: they are easy to get, with minimal requirements, and the needed cash becomes available instantly. And when the time comes to pay them off, the fees and interest will come out to around $10 to $30 for every $100 borrowed. In other words, if you borrow $1,000, you will have to pay back anywhere from $1,100 to $1,300.

Given urgent needs, paying an extra $100 or $300 won’t seem too bad, but all it takes is a closer look to reveal the exploitative nature of payday loans. The interesting thing with payday loans is that they are incredibly effective at masking high interest rates under the guise of small amounts. To make this concept easier to grasp, let’s say you borrow $10 from your friend and pay back $15 two weeks later. At first, that deal doesn’t look too bad, since you are only paying back with an extra $5. However, that is actually a 50% interest rate over two weeks. Over the course of a year, this would lead to an annual percentage rate (APR)—the yearly cost of borrowing, including interest and fees, expressed as a percentage of the loan—of 1,300%. Putting this into perspective, credit cards usually have an APR of around 30%. This same concept applies to payday loans. The small loan amounts make it easy to put on high interest and fees without catching the borrower’s eye, since the additional fees and interest payments won’t add up to much as a number. But, relative to the original amount borrowed, it’ll actually be quite substantial.

Payday loans, over a two-week period, can carry an APR as high as 800%. A 2016 report from the Consumer Financial Protection Bureau (CFPB) found that the median payday loan fee and interest payment added up to a little more than $15 per $100 borrowed, equating to a 391% APR for a two-week loan. These high yet seemingly hidden interest rates and fees are what make payday loans so bad, and since they are small amounts, they can lead to repetitive borrowing.

The Cycle of Debt

The reasons given by borrowers for taking out a payday loan (via lendup.com).

The high interest rates and fees associated with payday loans often trap borrowers in a cycle of debt. According to the same 2016 CFPB report mentioned before, about 80% of payday loans are rolled over or followed by another loan within 14 days. This basically means that most borrowers are unable to pay back the loan in full by the due date and must either extend the loan, thus taking on additional fees and interest, or take out a new loan to cover the original one. Eventually, this cycle leads to borrowers paying far more in fees and interest than the original loan amount.

As an example, imagine that you borrow $500 with a $75 fee, or 15%, for a two-week loan. If you can’t repay the $575 when your paycheck arrives and you roll over the loan, you will have to pay another $75 fee. After just a three rollovers over a period of six weeks, you will owe $300 in fees alone, while the original $500 loan will remain unpaid. The CFPB found that over half of all payday loan borrowers take out ten or more such loans in a single year, with the cumulative fees usually being more than what was actually borrowed.

Who Gets Hurt the Most?

Payday loans disproportionately affect vulnerable populations, especially people classified as low-income, people of color, and those with limited access to traditional banking services. A 2020 report from the Center for Responsible Lending (CRL) showed that payday lenders are concentrated in communities with higher populations of Black and Latino residents. The payday loan companies target these communities because they are statistically less likely to have access to affordable credit options, making them prime candidates for predatory lending.

Adding on, the CRL report also showed that on average, those taking out payday loans were earning $30,000 annually. This means that most payday loan borrowers are living paycheck to paycheck. It is morally wrong to target these people, but for companies giving out payday loans, that is where they can most easily make money. While the companies turn profits, the borrowers themselves are left in even more financial distress, leading to missed rent or utility payments, overdraft fees, or even bankruptcy.

Conclusion

As we can see, payday loans are incredibly predatory, and it is best to avoid them. They have very high interest rates and fees, much higher than even credit cards, and since payday loans usually come in small amounts, it can be easy to overlook them. As the data shows, the thing with payday loans is that they are not just a one-time thing. Most borrowers are forced to rollover their payday loans or repeatedly take out new loans to cover for their old loans. All of these are what make payday loans so exploitative and dangerous.

If faced with an urgent need for cash, go to family and friends instead and see if you can borrow from them. If that doesn’t work out too well, find stuff you don’t need in your house and put them up on eBay, Craigslist, or a yard sale, as this can help you raise a few hundred dollars. In the end, you can also negotiate with your creditors, landlords, utility companies, or whoever you may owe money to. Worst-case scenario, you can, if possible, try to wait out the problem until your next paycheck arrives. Emergency funds can be helpful during times like these, which is why it’s important to save up money as much as possible, even if it’s just $10 or $20.