If Visa offered you a credit card with an annual percentage rate of 391%, would you take it?
It sounds like a joke, but to the recipients of one of the most sinister and underhanded lending practices in the marketplace, it's truly no laughing matter.
The typical story goes something like this. Jim is strapped for cash, several of his bills are due (or past due), and payday isn't for another week. So rather than get hit with late fees or hurt his credit any worse than it already is, Jim decides to seek out what is known as a payday loan. He figures, "it's just like an advance on money that's coming my way anyway, right? Why not?"
So Jim takes a walk to his local payday loan center and writes a postdated check for $575 for a $500 loan. Two weeks from now, he'll have to allow the check to be cashed, pay back the full amount of the check by some other means (such as cash), or pay another fee to extend the loan.
Can you guess what $75 on a two-week loan for $500 works out to be in annual interest? That's right, 391% APR-- and what's worse, that's actually the low end of the spectrum when it comes to these types of loans. Payday loans have been known to reach upwards of 700+% APR (often the highest rates come from online lenders) with averages usually in the four to five hundreds. As an example, California's average is 460%.Once is Rarely Enough
If Jim only had to do this kind of thing once, it might be painful but at least it would be over quickly. The problem, however, is that using this kind of loan often creates a cycle of debt that can't be easily undone. The average borrower spends $793 to pay off a $325 loan because he or she ends up needing to take out more payday loans just to pay off the original, either because of a lack of funds available or because two weeks just isn't enough time to regroup.
According to the Washington State Department of Financial Institutions, one in four payday borrowers in that state took out loans between 10 and 19 times a year.The Very Definition of Usury
Payday loans often fall directly under the definition of usury, which is the act of lending money at an unreasonably high interest rate, as dictated by the state. Now, of course, many states have allowed payday loans, or payday lenders have used lending loopholes to their advantage, but certainly a loan with an APR in the three-digit realm can't be considered anything except "unreasonable."
As an interesting point of reference, the Roman Empire had a 12% cap on interest rates. The ancient Chinese had a 36% cap. The American colonies had caps between five and 12%. And between 1900 and the late 1970's, most U.S. states had usury caps between 18 and 42%. So historically we are way over the limit and into what amounts to legalized loan sharking.What Choice Do You Have?
The argument for payday loans is that they serve competition and may be the only alternative for people with severe credit problems. For those people, these loans could be the only thing standing in the way of bouncing checks or having to pawn their personal items. But if you know someone like Jim or have been tempted to take out a payday loan yourself, consider these alternatives:
- A small loan from your credit union or small loan company.
- A loan from family or friends.
- An advance on pay from your employer.
- A cash advance on a credit card (though it may have a higher interest rate than your other sources of funds).
- A local, community-based organization may make small business loans to individuals.
- Ask your creditors for more time to pay your bills. Find out what they will charge for that service - as a late charge, an additional finance charge, or a higher annual interest rate.
- Try working out a debt repayment plan with creditors and developing a budget.
- Find out if you have, or can get, overdraft protection on your checking account. The fees can be high but may still be lower than those of payday loans.
- Contact your local consumer credit counseling service. There are non-profit groups in every state that offer credit guidance to consumers and these services are available at little or no cost.
- Your employer, credit union, or housing authority may also offer credit counseling programs.
No matter what you choose, it's extremely important to shop carefully, compare offers, and look for the option with the lowest APR.
Between 2000 and 2004, the number of payday lender locations skyrocketed from 10,000 to 22,000. As of last month, University of Utah law professor Christopher Peterson said, nationally, there are now more payday lenders than McDonalds, Burger King, J.C. Penneys and Target stores combined.
The numbers are scary and several consumer watchdog organizations have released strong warnings against payday loans. The FTC posted a "Consumer Alert," the Consumer Federation of America set up www.paydayloaninfo.org as an educational resource, the United States Defense Department has a program in place that warns military service personnel against them, and our nation's capitol has effectively outlawed the practice by capping the interest rate at 24% (Payday Loan Consumer Protection Act).
The moral of the story? Stay away from payday loans. No matter how bad your financial troubles may seem now, they can always be worse.
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