What makes payday loans so dangerous?

If you need a quick cash advance, payday loans are accessible. You can go to your nearest lender with only an ID and paystub and the clerk will offer you a small amount of cash. However, payday lending is an insidious practice that targets low-income borrowers and can plunge them into a cycle of debt.

What are payday loans?

Payday loans are short-term, high-risk cash advances that rarely require a credit check. Loan sizes are offered in amounts of $500 or less. The repayment date is set in the loan agreement, which is usually two to four weeks from receipt, and typically falls on your next paycheck. The loan proceeds can be directly deposited into your account or provided by cash or check. Payday lenders can be accessed online and at their storefronts.

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The danger in payday lending comes from its interest rates. The loan’s interest rate typically will be advertised as a fee, ranging from $15 to $20 for each $100 borrowed every two weeks it’s late. However, when left unpaid, interest rates range from 300% to 500% annual percentage (APR). In comparison, credit cards range from 12% to 30%. As subject to the Truth in Lending Act, payday lenders are required to disclose the full cost of the loan, inclusive of the principal amount and annual interest percentage rate.

Before signing an agreement, consider the following alternatives to payday loans:

Contact your credit card company to extend your credit
Review other loan offers, such as an emergency loan
Ask a friend or family member to borrow money
Sell unused items for cash
Consider debt consolidation.

“By design, payday lenders target people whose financial obligations may outweigh their ability to quickly payback a loan.”

Payday loans create a cycle of debt

Borrowers seek these exorbitant loans as a last resort. Since they are unsecured, payday loans are designed for people with poor credit, dealing with unforeseen emergency expenses, or are unable to pay their living expenses. By design, payday lenders target people whose financial obligations may outweigh their ability to quickly pay back a loan. If they’re deciding between an eviction and a loan repayment, they will extend their loan. And due to the high interest rate, their debt compounds. For example, in just two months, interest on an unpaid $500 loan could potentially snowball to $900 of debt. Payday loans can plunge borrowers into a cycle of debt, forcing them to roll over their loan or take out a new one. If the cycle continues, they can end up paying more in fees than they borrowed.

Payday loans ruin credit

Although payday lenders rarely check a borrower’s credit, failure to repay a loan can damage it. Many payday lenders require borrowers to provide bank account information to ensure they receive payment. If they are unable to process the transaction and the loan is delinquent, the lender may sell a borrower’s debt to a debt collector. The collector can report this to credit reporting companies and hurt a borrower’s credit score. If you need to get approved for a loan and your credit is in disrepair, learn how to improve your credit score.

There are other emergency options to repay debt. Consider alternatives to payday loans, such as a short emergency loan, or a peer-to-peer loan. An emergency loan can help cover unexpected expenses and are highly accessible, with many banks offering funds in the same day. A peer-to-peer loan lets you borrow money directly from people with going through a bank.

Payday loans harm low-income communities of color

The exploitative nature of this lending practice doesn’t end in its structure; it extends into the communities it targets. Payday lender storefronts are typically concentrated in impoverished communities of color. According to an article entitled, “Fraud and Abuse Online: Harmful Practices in Internet PayDay Lending, “Black people make up roughly 13% of the total American population, yet they constitute 23% of all storefront payday loans.” Moreover, most borrowers are repeat borrowers, who take out more than five or more loans per year.

Thankfully, many states have outlawed payday loans outright, or enforce stringent regulations. Regulations include loan maximums, requirements to ensure borrowers can repay loans, as well as income and loan duration limits.

Navigating financial curveballs can be difficult, so stay on top of your finances with more budgeting tips.