Avoid the Pay Day Lending trap at all costs (because it will cost you dearly)

Dec 2, 2019
the cons of pay day lendingPay Day Lending sounds like a fine solution to a short term money need. The idea, is you take out a small loan with the agreement to pay it back on 'payday'.

But like Admiral Ackbar exclaimed in Jedi, 'Pay Day Lending is a Trap'.

This trap goes by the name of 'cash advance', 'paycheck advice' and the classic 'short term loan'. The companies themselves have names like Quick Kash, Advance Cash, Ezy Cash or some other 'wordplay' type variant. 

Whatever form they take, payday loans are not there for the consumer's benefit. 

They are often deliberately marketed at those with little financial literacy or those with bad credit reports and definitely at those need cash desperately.

It's a trap because it becomes a cyclical (cynical?) exercise of repayments that seem never-ending. These so-called 'salary loans' are nothing but a trap to gouge profits from people who probably can't even afford a standard bank loan.

Watch how people will turn to Pay Day Lending as the recession hits America because of the impacts of the Coronavirus. Covid-19 is going to cause people to go into debt as the work slows and people get laid off.

These kinds of loans are much easier to get than personal or bank loans. They have fewer hurdles to jump through as well. Usually, you just need some ID, be over 18 years old and have a regular form of income (job or benefit) and a bank account.

The basic loan process involves a lender providing a short-term unsecured loan to be repaid at the borrower's next payday. In the online realm, where a loan is not paid back on payday (with the finance charge on top of it) the loan is rolled over.

If the loan repayment bounces, the bank then causes a default charge to occur.

When the debt is not repaid back quickly, the debt builds up fast thus capturing the original borrower to a long term repayment plan.

What was a small loan suddenly becomes an expensive one for the borrower and it can be a slippery slope towards personal bankruptcy. In the US, it's considered that the use of the services of a payday lender can double your odds of entering into bankruptcy factor of two.

It's no real surprise then that many governments around the world have come down hard on payday lenders - it's now heavily regulated in many markets and in America alone, the practice is banned in 14 states and the District of Columbia. 

One of the tricks of payday lending is the marketing around them. Touted online and in newspapers as quick and easy finance, the effective interest rate is seldom mentioned. Instead 'fees' are used or merchant charges made - these will disguise the true cost of the loan which means the effective annual percentage rate (APR) of interest. APRS can reach over 300 percent to even 800 percent. 

These numbers are mirrored all around the world.  

No wonder then that many governments believe that interest rate caps are the answer. The actual merits of such a policy intervention are dubious - experience has shown that when a rate is set - lenders move to that rate, thus increase overall indebtedness of the community that the law change was trying to reduce. 

Go figure. 

Here's the loan trap in a worked example. 

Say it's Christmas time and you want to get the grandkids some decent Christmas presents. They are good kids but times are hard allround for the family. Or you are simply desperate after the effect of Coronavirus on the economy.

Enticed by some handy advertising that pulls at the heartstrings, grandma enters into a payday loan of 400 bucks, thinking she can pay it back by picking up some seasonal work after Christmas or she expects things will 'pick up' somehow. 

Maybe the economy will kick back into life. 

Whatever. 

As she enters the loan, she knows she will basically pay double what she borrowed back. 

Grandma misses that first payment after Christmas and now the repeat charges and fees that occur every 'payday' mean that she cannot get on top of the loan. With a limited means of income, she gets stuck paying the fees and not the loan meaning she's paying hundreds of percent of interest. Each week the debt gets rolled over. 

And rolled over. 

And rolled over. 

I've read that in the United States, one in four payday loans is rolled over 9 times. Three-quarters of the loan volume of the pay day lending industry was built up by borrowers who re-borrow before their next payment. 

And that comes at the expense of herself. Maybe she doesn't pay the power bill that month. Maybe she skips out on a visit to the doctor. Maybe she has to give up eating meat. 

If she's on this path it's because the predatory nature of payday lending led her here. 

That 400 buck loan has become a two thousand dollar nightmare. 

You might say, well it's simple to fix that. Get a credit card that will cover the debt owing at a vastly reduced interest rate. 

You tell me which bank will issue a credit card to a person in such a position. Especially a responsible bank operating under a code of social responsibility...

So our advice is to avoid getting a payday loan. And we know that's easier said than done. Especially if you need a quick loan to pay the mechanic so they'll release the car so you can get to work so you can earn money to pay the rent (Pro-tip - befriend your local mechanic. In my personal experience, an honest relationship with good rapport will often lead to a lot of wiggle room on car bill repayment times). 

If you do need to enter into this trap, the smartest thing to do is shop around and compare rates and fees across providers.  

Your local budgeting organizations will know which are the 'best' payday lenders to use. Some lenders have 'socially responsible practices'  (ha!) which limit the original loan's effective repayments at double the original loan value. 

If you already have a credit card and you are not maxed out, it's literally in your interest to use the card over getting the payday loan. 

The only benefit of a payday loan is that they are generally unsecured. That means if you default, the repo man can't come and take away and sell your possessions to repay the debt. That doesn't mean the debt collectors won't come knocking. The original lender will happily sell your debt to an agency that thinks they will be able to collect from you. 

If you are thinking of a longer-term game in terms of your personal finance strategies - building up a good credit history that demonstrates an ability to replay back debt will go a long way to convincing a regular bank to grant you a personal loan.

Still not convinced?

Perhaps this savage critique of the payday lending industry by John Oliver:



How to get out of a payday loan debt cycle


Good on you for realizing the trap you are in and deciding to do something about your debt.

Here are some tips on how to free yourself from these debts. It won't be easy and you'll need to work at it over time. 

  • Pay off the loans with the highest debt first. This reduces the total amount you'll end up paying over time. 
  • Refinance - it's sometimes possible to take out a cheaper line that pays off the more expensive one. Personal loans and credit cards have vastly lower rates - yes, we appreciate this won't be an option for everyone. If you have a local Credit Union - check them out, you may be surprised what services they can actually offer you. Many unions have products designed to be used instead of PDL - these are called PALS - PayDay Alternative Loans. 
  • You may have to bit the bullet and seek help from friends or family. 
  • Go to a budgeting service for advice, work with them to set a budget and damn well stick to it. 

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