Payday Loans: Fact vs. Fiction

By: Javi Calderon
Payday Loans: Fact vs. Fiction

The payday loan industry has been under fire in recent years, resulting in very biased and one-sided negative press regarding the business of offering subprime loans. Politicians and the media seem to have settled on the terms “predatory” and “cycle of debt” to describe and define the industry, choosing to focus on the miniscule fraction of loan consumers who find themselves unable to repay their original loan and thus resort to rolling the loan over.

A loan rollover allows the consumer to extend the life of the loan while adding on an additional fee or interest rate to the original principal.

It is undeniable that some loan consumers have exacerbated their already difficult financial situation by mismanaging their cash advance loan. However, CFSA studies show that over 90% of payday loans are repaid by the end of their original cycle and independent reports done by the Federal Reserve and Clemson University concluded that no statistical evidence supports the claims that these loans trap the borrower in a “cycle of debt.”

Critics claim that payday advance loans prey on the poor, but the facts tell a different story. While payday loans have found a niche as a financial product that serves the low income community (that otherwise would not have an option for borrowing money) they also serve the middle class. Around 40% of borrowers claim an income of $40,000 a year or more, 90% have at least a high school diploma and 54% have attended college.

States like Montana and Arizona, amongst others, have placed interest rate caps on payday loans in hopes of preventing payday loan lenders from charging egregious and outrageous rates. To set these caps they used an APR or annual percentage rate. An annual percentage rate is what the interest would be if the loan were extended to a year. Keep in mind, payday loans are usually 14-days or a month long!

Let’s take a look at the numbers: a payday advance of $100 with a $15 fee amounts to an APR of 391%. Arizona and Montana capped their APR at 36% meaning that lenders would have to charge around $1.30 to pay out a $100 loan. Obviously, this isn’t even profitable for the business.

Laws like these in effect make payday loans illegal but the alternatives would be even more costly. A $100 bounced check would come with a $56 penalty, resulting in a much steeper 1,449% APR. An unpaid $100 utility bill with a $46 late and reconnection fee would equal an APR of 1,203%.

As you can see, the alternatives to taking out a consumer loan would be much more costly, and using APRs to evaluate payday loans is absolutely nonsensical.

Cash advance loans have found a niche as a quick solution to unexpected monetary problems. People with poor credit turn to them in times of need; people who need a few hundreds dollars (a loan too small for a bank) use them as well. Does a state government step in to help someone who is going bankrupt? Someone who is going out of business? Or who has amassed thousands of dollars in credit card debt? The answer is no. So what makes the consumer of a payday loan different?

Payday loans are a financial product with risks, just like any other. Yes, the lender is responsible for offering services that can help the borrower but it is the consumer whose financial lively hood is on the line and therefore the consumer who should take responsibility of their financial decisions.

A payday advance loan is a reasonable and safe solution to short term and unexpected financial situations, not for long term financial problems. Use them as intended and read and understand all stipulations of a loan before signing.