Legal Loan Sharks
Okay, kids. It’s quiz time!
What is the most expensive legal form of credit available to you?
If your answer is a secured credit card at 24% APR, you are off by a mile. Try getting a payday loan.
Payday loans, also known as deferred presentment, are currently available in 20 states plus the District of Columbia. They are short-term loans, generally 7 to 14 days, against a post-dated check. In Arizona, this loan against the paycheck you haven’t yet earned carries a 15% fee. On the average payday loan of $300 for eight days, this 15% fee equates to an APR of 459%!
Check cashing and payday loan shops are popping up like mushrooms in plaza storefronts around my downtown neighborhood in Phoenix, Arizona. Signs announcing “Cash King coming soon” appear at 7th Street and McDowell next to the Starbucks and at Central and Thomas between the florist and the dry cleaner.
Will people take an advance on next week’s pay to buy a Mocha Frappuccino, I wonder? Will they borrow to retrieve their dry cleaning or to buy flowers for their girlfriend? As Cash King joins Cash One, CheckMate, EZLoans, Money Mart, –there are more than 250 shops in the state of Arizona with one-third in the City of Phoenix–I have to wonder. Is there a need for payday loans?
According to the payday loan propaganda, everybody needs a payday loan. It’s a quick, no-hassle way for consumers to secure small, emergency loans, with little or no red tape. They claim payday loans serve an under-served market because neither consumer finance companies nor banks are interested in originating $100 to $500 non-secured loans.
Yes. A payday loan is quick and relatively hassle-free. You write a check to the payday loan people for the loan amount plus fees. (In Arizona the loan can be from $50 to $500 and the maximum fee is 15% of the loan amount.) You postdate the check to the date of your next payday. They give you cash for the loan amount. You agree to either bring in the cash in exchange for your check or allow them to automatically debit your bank account on your next payday.
There are several problems with this arrangement.
- First, the fee you pay for the use of this money is exorbitantly high. Think of it this way: by borrowing your pay in advance, you are settling for a 15% cut in pay.
- Second, if you can’t make it through to the next payday without a loan, and you’re already spending next week’s pay, how will you ever make it through next week without another loan? This can be a vicious, and very expensive, cycle.
- Thirdly, it is considered fraud to knowingly write a bad check in many states (including Arizona). This means that on the off chance that you don’t reclaim your check on the agreed date, they will deposit it anyway. “Bad check” laws in many states (including Arizona) allow them to take you to civil court for three times the amount of the check plus court fees.
- And, if your check bounces, they will charge you an NSF fee of up to $30. Don’t forget that our own bank will also charge you an NSF fee.
- Can it get any more expensive? Unfortunately, it can. They can also prosecute you for fraud if they are so inclined.
How can they legally lend money at such exorbitant interest rates? By simply not calling it “interest.” Payday loans charge a “fee” which makes them exempt from the standard usury laws that cap interest rates. In Arizona, the legalize reads like this: “The fee charged by the licensee is not interest for purposes of any other law or rule of this state.” Arizona (along with 19 other states and the District of Columbia) has given the green light to loan sharking.
Payday loans take advantage of clients who lack financial savvy–who never stopped to think about the “cost of money” or who, quite simply, don’t budget well enough to have $300 in the bank in the event of an unexpected expense.
Spending money before you earn it, the enticement offered by payday loan companies is diametrically opposed to anything you will learn in any financial planning book or class. The commonsense rule is this–earn money, pay yourself first (by putting a percentage into savings or some other investment vehicle), then spend. The initial pain of budgeting will quickly be replaced by the good feeling you’ll get from reaching a goal.
Although budgeting and saving defer spending a little, it costs much less in the long run to buy needed items with cash from your savings. Instead of paying 15% (at an APR of 459%) for the privilege of purchasing something today, you earn interest on the savings until you are ready to buy. In effect, you will have more money to spend by the time you get around to spending in the future.
Contrary to what they say, payday loan shops are not in business to help you through a one-time financial emergency. The payday loan propagandists claim that this unexpected expense is their reason for existence, but, in reality, the regular customer is their bread and butter.
One Web site touting the advantages of opening a loan shop claims an annual return of 805% for investors! Their best estimates of the average returns possible for one payday loan store:
Monthly volume for 1 store: 575 checks
Average loan: $300
Average fee: $15 per $100 advanced
Total monthly loan volume: $172,500 ($300 X 575)
Total monthly fee income of one payday loan store: $25,875 ($172,500 X 15%)
Who’s fooling whom? If the payday loan shop operator is winning that big on their investment, it’s because the rest of us are losing just as big.
Heed some sage advice, paraphrased from the Consumer Federation of America:
- Make a realistic budget and live it. You will have savings so you will never need to borrow small sums to meet emergency expenses. (By not paying the fee on a typical $300 payday loan for seven paydays, you will have your own $300 savings for a financial emergency.)
- Shop for the lowest cost credit available from cash advances on credit cards, small loans from your credit union or a small loan company, an advance on your pay from your employer, and loans from friends or family.
- If you need money to pay a utility bill, ask the utility company for an extension. Look into the late fee they charge. Is it less than the 15% fee from the payday loan folks?
- Consider getting overdraft protection on your checking account. My credit union charges nothing for this service if used only once a month. If your bank has an overdraft fee, find out what it costs. If it is less costly than the payday loan, use it.
- If you must use payday loans, borrow only as much as you can afford to pay with your next paycheck and still have enough to make it to the next payday. Otherwise, you will become the payday loan industry’s dream client–returning every payday for a loan.
- If you have ongoing financial problems, seek help. Budgeting and debt management counseling is available from credit unions and local non-profit agencies.
In closing, I am asking you all to help rid my neighborhood and yours of payday loan shops and all their lovely neon. Use your credit options wisely. Budget and build your savings. Don’t use these expensive services. If no one ever steps inside their doors, they’ll go away.