This week, David Lazarus of the Los Angeles Times wrote about the perils of applying for payday loans online. Though he brings up good points, many of the column’s positions on payday loans were blown out of proportion, and his attacks on the industry, while valid, only tell one side of the story.
But a media figure’s view on payday loans is often much different than the consumer who knows he or she must take out a loan to survive the month ahead. All sides can agree that payday loans are hardly ideal, but myths still surround short-term borrowing, often with negative connotations.
When separating fact from fiction, the devil is in the details, and potential borrowers can do well to learn the truths behind payday loans before being swayed by public opinion.
Myth 1: Borrowers end up paying astronomical interest rates.
“What we’re actually talking about is a sneaky way of pitching payday loans that can come with annual percentage rates as high as 700%,” writes Lazarus in his column. At face value, Lazarus is right: payday loan annual percentage rates, or APRs, do get into triple digits.
What he doesn’t tell readers is that the APR isn’t actually what the borrower pays, this is hypothetical amount of interest and fees the customer could expect to pay over the course of a year. But a payday lending study done by The Pew Foundation earlier this year revealed that the average payday loan length is 18 days, a far cry from the 365 needed to reach the actual APR.
In reality, the APR charged to a payday loan, while high, isn’t nearly as intimidating as the 700 percent Lazarus quotes. A survey conducted by the Colorado Uniform Consumer Credit Code (UCCC) recently revealed that the average payday loan amount in their state was $373. The average amount of interest (including charges and fees) was $276, making the average interest rate of payday loans 63 percent.
While much higher than credit card or traditional personal loan rates, 63 percent is much less than 700 percent.
Myth 2: Borrowers often take out new loans to pay old ones off.
A common belief is that two weeks simply isn’t enough time to pay off a loan. That one payday loan is usually paid with another one, and so on, ad infinitum, until the borrower is in a much worse financial position than he or she started in.
“The problem is that you’re borrowing against a future paycheck. When that check comes in, you may not have enough to pay off the loan or to cover new expenses,” writes Lazarus. “And so you take out another loan. Before you know it, you’re trapped in a perpetual cycle of high-interest payments.”
The only problem? It’s not always true. The UCCC study found that more than 76 percent of borrowers in the state paid off their payday loan in full within six months. With more than three-quarters of borrowers seeing their loans through from beginning to end, the myth of a perpetual debt cycle is exaggerated.
While the concept of a loan cycle is overstated, the danger of expanding debt is real. Borrowers should only take out one loan at a time, only as needed, and repay their loans before considering other short-term alternatives.
Myth 3: Communities would be better off without payday loans.
Of online payday lending, Lazarus writes: “These are eel-infested waters, and you don’t want to swim there.” In a perfect world, then, cities and towns across the U.S. would be free of payday lending and its exorbitant rates and fees.
But in payday loans’ place car title loans blossomed, a far worse product, one capable of repossessing personal property and putting borrowers in potentially worse financial situations. In fact, that’s just what happened: car titles in Virginia quickly became a thriving, $125-million-per-year industry that impounded nearly 9,000 cars in 2011.
The need for payday lending is clear only in relation to similar products, like car title loans, or penalties, like overdraft fees. In communities that don’t have access to payday lending, more consumers are forced to overdraw their bank accounts, while others must settle for late and altogether unpaid bills.
Payday loans should not be a consumer’s first borrowing option. But by comparing them to the alternatives – negative-balance bank accounts, late charges, shut-off utilities – they are a manageable solution when used properly. Payday lending isn’t a day at the beach, but it’s hardly the eel-infested swamp it’s made out to be.