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Depending on where you live, the following stat may not shock you: there are more payday loan companies and speedy cash lenders in the US than the combined number of McDonald’s and Burger Kings.
What should be shocking is that unlike McDonald’s and Burger King, fringe lenders can only legally do business in 36 states. And when fringe lenders are able to do business in your state, rates average as high as 391 percent. When you do the math using real-world scenarios, it gets ugly.
But here’s a stat that should shock you: despite the reputation of payday loans being good for emergencies, people don’t actually use them for emergencies. 7 in 10 borrowers use them for essential expenses, such as rent, and utilities. For a country where 4 in 10 Americans can’t avoid debt to pay for a $400 dollar emergency expense, that’s kind of a big deal. But let’s get back to some math:
(Disaster Math) How Payday Loans Actually Work
Let’s say you have a $100 water bill you can’t pay off right now. You decide quick cash is the best option. There’s a reason payday lenders are attractive in an emergency; they work quickly. You can have between $300-$1000 in cold cash in just 15 minutes, or the morning directly after.
Let’s break down why the math on these loans isn’t even legal in 14 states.
Payday loans consist of three easy pieces: your principal (that $100 water bill), a finance charge (typically $15), and your repayment term (typically 14 days). The math seems easy. “You mean all it costs to borrow $100 for a two-week period is the same amount of money I pay in a single can of unicorn meat?”
No. It works like this. Look back at the numbers above. The number you’re really looking for is the annual rate on your loan. How you figure that out is a little complicated. If you want to grind through the math, check out the formula here. The important takeaway is that the above numbers lead to a 391 percent rate! If you’re a little confused or bad at math like me, you might be wondering what a year has to do with borrowing $100 for a two week period.
That’s because payday lenders may not know you, but they know people. If you couldn’t afford that extra $100 this month, what are the chances you can afford to pay back that $100 next month, or the month after that? As such, debt tends to roll over. And it rolls over at the same rate. In fact, 80 percent of all payday loans are either followed by another loan within 14 days, or rolled over. This rollover is why the average payday loan borrower is in debt for five months. Monthly borrowers are especially vulnerable, as they are more likely to stay in debt for up to 11 months. As a result, the average payday loan borrower spends $520 in fees just to borrow $375.
But that’s not even the half of it.
It Gets Worse: “…monetizing poor people…”
The price of borrowing is high. But the price of borrowing while poor is even higher. The video above is well worth watching. It’s the story of Stephen Huggins; an equipment operator from Nashville who received a check in the mail to borrow $1,200, but who ended up with a $3,221.27 fee when Mariner Finance (his payday lender) took him to court.
If you’re wondering how this happens, it’s pretty simple. The price to borrow on payday loans is typically made up in various fees. For example, in Huggins’ case, he had a finance charge worth $496. He also had a processing fee worth $800, bumping his total to borrow to $2684. Then there was the fine print on his loan, stating that Huggins was responsible for the company’s attorney fees, which cost over $500.
Typically, the most important loans are the loans you take out on a house or a car. Unlike payday loans, home or car loans require money to be spent toward your debt timeline. These payments (referred to as ‘amortization’) are where you ensure that your loan and the interest on that loan is being paid off.
Payday loans don’t have these timelines or schedules, which sounds like a good thing at first. Except the lack of scheduled payments means uncertainty for already uncertain customers. A good chunk of those who borrow from payday lenders are enrolled for a 10-loan period. It’s easy to see why, especially for cash-strapped Americans; the same path towards using payday lenders is the same path that gets borrowers stuck — not being able to pay for things in a timely manner.
Borrowing is always a risk for everyone involved. But sometimes an industry is a risk unto itself.
Nightmare on Excel Street
In 2016, a man named Joel Tucker was sued by the Federal Trade Commission for inventing 7.7 million fake debts. He was indicted this July for selling excel spreadsheets with false debts from real people to brokers who then sold them to collectors.
Not to be outdone, his brother, Scott Tucker, was also convicted of illegal lending. American Indian tribal lands don’t have usury laws, allowing payday lenders to charge interest rates as high as 700 percent (!).
Their online payday lending businesses operated under brand names including Ameriloan, Cash Advance, One Click Cash, United Cash Loans and 500 FastCash. In addition to steep interest rates, authorities said consumers were tricked by the terms of the loans through renewals and fees. Prosecutors said a $500 loan could result in a borrower owing $1,925.
This is part of the problem with using payday lenders. The business is complicated. In Joel Tucker’s case, he ran a software company that didn’t make loans, but sold applications filled with personal information to payday-lenders. This is why a good credit repair company can be helpful; part of their job is to ensure that all the information on your credit report is legal and verifiable.
For people that need quick cash, and can’t go to the bank of mom and dad, what alternative do they have? Getting qualified for a personal loan is difficult because banks have rigid standards. For example, the minimum credit score to qualify for a personal loan is 640. That’s why 1 in 4 households either can’t use banks, or are underbanked and must go through payday lenders for quick cash.
You’ve probably heard this expression: “Give a man a fish and you feed him for a day. Teach a man to fish and you feed him for a lifetime.”
Good credit is the ‘teach a man to fish’ part, and why it’s recommended (like anything else, make sure to shop smart and compare companies). Your most important purchases, such as buying a home, become cheaper. It also means you get to do business with lenders you can trust.
Here’s an example. Buying a $15,000 car with poor credit (500-600) can result in a monthly rate of $357. With good credit (661-780), rates can go down from 15% to 5%. That 10 percent difference can result in a $357 payment over five years versus the $283 payment with better credit.
Know how much you end up saving over that five year period? $4,440. I’ll repeat: that’s $4,440 saved over five years just for having a good score to pay less per month, resulting in literally thousands saved. Patience pays; literally.