There are few things more stressful than needing money and not having it. An unexpected car repair, medical bill, utility payment or back-to-school expenses can leave someone feeling like they have nowhere to turn. That’s exactly where payday loan companies often enter the picture, promising quick cash with little hassle and few questions asked.
This topic is very personal to me. Years ago, I was very close to someone who became caught up in the payday loan cycle and was frighteningly close to never getting out of it. What may have started as a relatively small loan became a recurring financial burden. That experience reinforced something I’ve seen throughout my career as a banker and now a financial advisor: a financial solution that solves today’s problem but creates a new problem tomorrow isn’t really a solution at all.
The payday loan industry markets convenience. The message is often some variation of: Need cash? Get approved quickly. Bad credit…no problem! Get money today. For someone under financial pressure, that message can sound attractive. Their marketing focuses on how quickly you can get the money rather than how difficult it may be to repay it.
Payday loans are designed to be short-term, generally small-dollar loans that are due within two to four weeks. The problem is the overall cost. A typical payday loan fee of $15 for every $100 borrowed may not sound outrageous at first, but on a two-week loan, that works out to an annual percentage rate of nearly 400%. And that’s where the real danger starts.
The repayment structure can make matters worse. Suppose you borrow $500 and owe $575 on your next payday. If you don’t have $575 available after paying your rent, utilities, groceries and other necessities, you may find yourself borrowing again simply to deal with the first loan. Or if you don’t pay the loan back on time, you may face additional fees from both the payday loan company and your bank. A small emergency need can quickly snowball into a much larger financial burden, leaving people trapped in a cycle that becomes increasingly difficult to escape.
The payday loan company business model depends on fees and repeat borrowing, which means the customer who pays off the loan quickly may actually be less valuable to the lender than the customer who keeps coming back.
Some lenders allow borrowers to roll over or renew loans, creating additional fees. Research from the Consumer Financial Protection Bureau (CFPB) has found that more than four out of five payday loans were re-borrowed within a month. That’s how a temporary cash shortage can become a long-term debt problem.
So what should you do if you desperately need $500?
First, talk to the person or company you owe. A utility company, medical provider, landlord or other creditor may be willing to give you additional time or establish a payment arrangement. You’ll never know unless you ask.
Second, talk to a credit union or community bank. Credit unions may offer small-dollar loans or Payday Alternative Loans (PALs) with substantially more manageable terms than traditional payday loans. Banks may offer their own small-loan solutions, as well.
Third, look for ways to create temporary cash without creating expensive debt. Could you sell something you no longer need? Have a garage sale? Pick up extra work? Delay a nonessential purchase? Ask a family member for help? None of these options may feel ideal, but they can be far less expensive than getting involved in a cycle of high-cost borrowing.
Finally, if payday loans have already become a problem, don’t simply keep borrowing. Ask for help. A financial advisor, nonprofit credit counselor or trusted financial professional can help you put together a plan to break the cycle.
So if you’re considering a payday loan, take a deep breath before signing. Calculate the total cost – not just the amount you’ll receive today. Quick cash can be tempting, but a loan that keeps you borrowing paycheck after paycheck can cost far more than the emergency that caused you to borrow in the first place.
Tracy L. Campbell is a partner and financial advisor at Meriwether Wealth and Planning, an independent Registered Investment Adviser (RIA) firm headquartered in downtown Minden, La. E-mail Tracy at tracy@meriwether.com. Disclaimer: This content is for general knowledge and education, not a substitute for professional advice.