They're called many names: payday loans, cash advance loans, check advance loans, post-dated check loans, or deferred deposit loans. What they are, though, are short-term, high-interest-rate loans for those who need a little extra cash until their next paycheck.
If you're not familiar with this game, this is how it goes: Generally, a borrower writes a personal check payable to the lender for the amount borrowed — plus a fee, which represents the interest. The lender pays the borrower the amount of the check minus the fee, and holds the check — usually until the borrower's next payday.
The same result can also be accomplished electronically: The lender deposits the amount borrowed into the borrower's checking account, then debits the loan amount — plus a fee — the next payday.
That fee will vary. Sometimes it's a percentage of the face value of the amount of the loan. Other times it is a set charge per every $50 or $100 borrowed. Either way, these loans are known for being a costly way to make ends meet. So costly, in fact, that payday loans are banned or significantly restricted in 18 states and the District of Columbia, according to the Center for Responsible Lending.
Some states have interest rate caps (often 36 percent or less); others don't allow these loans at all. The average APR is 417 percent based on a 10-day loan. From bank lenders, it is a little lower: 365 percent.
Payday loans also tend to suck borrowers in. According to CRL, the average payday borrower takes out nine loans per year and borrows more and more over time.
Its report says "payday lending can lead to negative financial outcomes for borrowers; these include difficulty paying other bills, difficulty staying in their home or apartment, trouble getting health care, increased risk of credit card default, loss of checking accounts and bankruptcy."
It's clear the primary trouble emerges when borrowers don't pay the money back immediately. Every time the loan is extended or "rolled over," new fees are tacked on. (Some states disallow or limit rollovers.)
Say you need to borrow $100 for two weeks and the fee is $15 (that's an APR, annual percentage rate, of 391 percent). If, 14 days later, you're not ready to pay it back, you'll pay another $15. Do this three times and you're up to $60 on a $100 loan.
Even if your state doesn't allow payday loans, your bank may offer a product called "checking account advance" or "direct deposit advance" loans. They work in much the same way: Generally, the bank deposits the loan into the customer's account and then repays itself the loan amount, plus a fee, directly from the customer's next direct deposit. But there are better ways to get out of a jam:
- Use a credit card. Payday lenders are required to disclose the APR in writing before you sign for any loan. Compare that APR with other alternatives, like a credit card. If you have one, even at a high rate of interest, you're better off than with a payday loan. Even a cash advance from your credit card is typically cheaper than a payday loan.
- Overdraft protection. I've told people, again and again, not to opt in for overdraft protection on their checking accounts. Why? Because it's expensive and you're better off having your debit card declined. But if you need to access funds and you have no other way, overdrawing your checking account will cost you around 18 percent interest. That's far better than the APRs on payday loans or direct deposit advances.
- Get a handle on your debt. If you're falling behind because a large portion of every paycheck is going toward minimum payments on your credit cards, you should seek help with a good credit counseling agency. And if you are in a cycle of payday loans and you don't see a way out, I urge you to do the same. Find a good agency through the National Foundation for Credit Counseling (www.nfcc.org).
- Try to break the cycle. The best way to stop living paycheck to paycheck is having an emergency fund. Even if you have $100 in a savings account at your local bank, it's better than nothing and can help you if you find yourself behind or in need of some quick cash to cover an unexpected expense.