Destroy Your Debt

How Do Payday Loans Work?

Updated on March 22, 2020 Updated on March 22, 2020
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"No loan is free." —Barbara Corcoran

Many of us have been desperate for money. Some of us have considered instant payday loans.  But these are the worst solution to the problem.

If you are in a dire situation and considering taking a payday loan, please read this and reconsider. You will be digging yourself a hole with a backhoe and trying to dig your way out with one of those tiny spoons they use to serve caviar.

What Is A Payday Loan?

A payday loan is a short-term, unsecured loan for a relatively small amount of money that carries a very high rate of interest. Generally, the borrower writes a personal check for the amount they wish to borrow, plus a fee, and is given cash in return.

If you’ve ever bought a home, you know how much documentation the bank wants before they approve you for a mortgage. Not so with payday loans. Many lenders will require only proof of employment, like pay stubs or bank statements, and one or more forms of identification. Some larger lenders allow you to apply online and you can have an answer in as few as five minutes.

And there are a lot of them in the US. More of them than there are McDonald’s in fact. There are 14,000 of the fast “food” outlets and 20,000 of these kind of predatory lenders.

Who Uses Them?

In 2012 The Pew Charitable Trusts released an extensive report on payday loans. Twelve million Americans per year use payday lenders and borrow $7 billion. The typical user borrows an average of $375 eight times a year and pays $520 in interest.

Most borrowers are white females aged between 25-44. After controlling for other characteristics, Pew found that there are five groups more likely to use payday loans:“those without a four-year college degree; home renters; African Americans; those earning below $40,000 annually; and those who are separated or divorced.”

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What Are They Used For?

Most loans are not used for emergencies as you might expect. Most are to cover day-to-day and recurring expenses like utilities and groceries, which is actually more frightening. Many people will experience an emergency expense at some point and not all of them have an emergency fund. But that people are taking out these loans for food is a scary thought.

The Importance of Having an Emergency Fund

The Importance of Having an Emergency Fund

In fact, 69% of loans were for everyday expenses and just 16% were used to cover an emergency.

Why Are They Bad?

The typical two-week loan will have an interest rate of between 391-521%! The average APR for a credit card is in the mid to high teens; for a bank loan it’s about 7%. So as much as we warn you against maxing out a credit card at LMM, if it’s a choice between that and one of these loans, use the card!

These kinds of loans often turn into a viscous circle for the borrowers. When the loan comes due, they can’t pay it back. So they take out another. You can see where it leads. I listed the statistic above that the average borrower takes out eight of these loans a year.

If it were one and done, it would be painful but over quickly. But because the borrower takes out more than one, they will spend an average of five months out of twelve in this kind of debt.

Payday lenders are among the most notorious for harassing borrowers in arrears. They will often threaten jail and call incessantly. The Fair Debt Collection Practices Act put in place rules to stop this kind of harassment but many people are not aware of the laws or their rights and believe they could be thrown in jail if these debts aren’t paid back.

The third-party companies hired to collect the debts are aware that most people don’t know their rights so they make all manner of outrageous threats. Everything from jail to involving CPS to remove children from the home.

Crackdowns On Payday Lenders

Some states have banned payday lenders entirely while some have put strict rules in place regulating the practice. The Consumer Financial Protection Bureau may put federal regulations in place. But because this is America, there will be one law and a thousand exceptions. The best way to combat these kinds of predatory lenders is to educate the consumer. So I wrote this article!

What Can You Do Instead?

Just about anything else, please! You don’t need two kidneys do you? Any spare children you have lying around would probably fetch a nice price on the open market.

Seriously though, work up a Plan B if you are headed in this direction. When Pew asked what borrowers would do if payday loans were not available, 81% said they would cut expenses. Others said they would delay paying bills, borrow from friends or family, or sell some possessions.

I can only guess that those questioned didn’t use one of those alternatives because they weren’t aware of how dangerous a game this is to play. But you know now. Any of those suggestions are better than getting caught up in a never-ending loan cycle.

If I’ve written this too late for you, you can still get some help. Join Ready For Zero. They will help you manage your debt. Lending Tree might be able to help you too. Get a weekend job, drive for Uber. Whatever you have to do to get out from under triple-digit interest.

And we here at LMM are here to help too. Join our community to get help and advice from people who have been there.

Featured Image Photo Credit: “Wild silvertip shark” by Albert kok from Wikipedia

Candice Elliott - Senior Editor
Candice Elliott is a substantial contributor to Listen Money Matters. She has been a personal finance writer since 2013 and has written extensively on student loan debt, investing, and credit. She has successfully navigated these areas in her own life and knows how to help others do the same. Candice has answered thousands of questions from the LMM community and spent countless hours doing research for hundreds of personal finance articles. She happily calls New Orleans, Louisiana home-the most fun city in the world.

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