Posted by Lending Club :: July 25, 2007 @ 6:53 amThere are many ways to finance unexpected expenses or get through times when you’re running short on cash. The advantages of using Lending Club over credit cards in these situations have been covered quite extensively. Another alternative, the payday loan, is one that we hope you avoid.
A payday loan basically allows you to write a check to yourself for a fee in exchange for cash. Payday loan companies will then hold your check until you have the money to cover it, presumably on your next payday. The payday lender will charge you interest, in the form of a fee, for the convenience of this service.
However, the interest charge by payday loan companies tends to be extremely high. In their report titled Financial Quicksand, The Center For Responsible Lending reports that the interest rate on payday loans generally ranges between 391% to 443% APR!
With such high interest rates, it’s clear that payday loans can quickly become difficult to pay off. Payday loans are marketed as one-time, short-term loans. The high interest rate often forces many borrowers to extend their loans, incurring an additional interest fee. The same report, cited above, states that payday lenders “collect 90 percent of their revenue from borrowers who cannot pay off their loans when due, rather than from one-time users dealing with short-term financial emergencies.”
How much will a payday loan cost you? If you borrowed $1,000 at 391% APR ($15 fee per $100 borrowed every 14 days) and needed 6 months to pay it back, you would be charged $1,800 in interest! If you were to borrow the same $1,000 with a P2P loan from Lending Club, assuming an interest rate of 10% (rates start at 7.45%), not only would you have 3 years to pay it back, but the total interest paid would only be $162 over 3 years.
As you can see, payday loans are one of the most expensive ways to borrow money. If you need to borrow money, even if you think it’s only a short-term need, you might want to avoid payday loans at all costs.
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8 Comments
Just a few corrections to your question..."How much will a payday
loan cost you? If you borrowed $1,000 at 391% APR ($15 fee per $100
borrowed every 14 days) and needed 6 months to pay it back, you
would be charged $1,800 in interest!" One, the average payday loan
is $300 and many states limit the maximum amount of a payday loan
to much less than $100. Second, it's a two-week loan, not a six
month or annual loan. To apply an annual percentage rate to a
short-term loan just doesn't work. So, using your example, if you
borrowed $100, you would owe $115 in two weeks. If you could not
pay the loan back when due, members of CFSA, the national trade
association of payday lenders, are required (as of July 31) to
offer an extended payment plan at no additional cost, giving you
additional time to pay the loan back.
lynz, Thank you for your comments. The example in the post used
$1000 as a loan amount since that is the minimum loan size
available through Lending Club. Consumers deserve to have
comparisons that are equal and easy to understand. That also
warrants the use of an APR. By calculating an APR on a short term
loan, people get to see how expensive these payday loans can be. We
all agree that if the loan could be repaid in two weeks, that it
would cost less then in our hypothetical example. The sad fact is
that payday loans, regardless of how they are marketed, are in many
cases not short-term two week loans. As the report referenced in
the post explains, payday lenders "collect 90 percent of their
revenue from borrowers who cannot pay off their loans when due,
rather than from one-time users dealing with short-term financial
emergencies." I would be interested to see the details of the new
requirements for CFSA members regarding free extensions of payday
loans, that you mentioned in your comments. That sounds too good to
be true, but would certainly be a step in the right direction.
According to the CFSA's website, their members constitute around
half of the estimated payday lenders in the United States. So that
still leaves roughly 11,000 payday lenders in this country that
will not be bound by this new requirement.
While I don't know the qualifications of the P2P loans you talk
about, I do know that most people that take out a Payday loan do
not have the credit necessary to borrow mony elsewhere. I am a
single father with cancer and because of unpaid medical bills that
Medicade does not cover, I have poor credit. I am not able to get
short term loans from the typical sources most people have
available to them. I have no problem paying $15 for $100 that saves
my apartment or covers my prescriptions. As for the people that
never pay off the loans, last I checked, there was no law against
being stupid. I pay off my loans when due and only borrow when
absolutely necessary. If others are not that smart, it shouldn't
stop me from using the service.
If the minimum loan available through Lending club is $1000, then
Lending Club is not even in the same market as 99% of legitimate
payday loan (PDL) organizations, and particularly any member of the
CFSA. Very few states allow payday loans to total more than $1000 -
most are in the $500 - $700 range, and as noted above, more than a
few limit loans to $100. These loan totals are also cumulative - if
the state allows a maximum of $700, and Joe Schmoe has an
outstanding loan of $400, he may only 'add-on' to his existing loan
an additional $300, for a total outstanding loan of $700. If Joe is
a total and complete financial moron, he can then go to another
company and do the same - never underestimate the ingenuity of
fools! Also, as KL stated, PDL lenders make loans to people who
otherwise would not qualify for loans through any other form of
lending institution. As to the high APR, comparing based on an APR
doesn't work well, since the period of the loan is seldom more
thatn 1/24th of a year! Try instead comparing the total cost of the
loan over the full length of the loan (Cost of Borrowing, or COB),
and things look a bit different - although I am no great
mathmatician, I can figure out that a $300,000 mortgage at 6% over
30 years will cost me about $347,515 in interest - so while a PDL
is 15% COB, but about 400% APR, the mortgage is 6% APR, but about
116% COB! Even the Lending Club loan used as an example in the
original post would be a 16.2% COB - actually higher than a PDL
would be!
Grady, Thanks for your comment. First, a quick note to clarify that
Lending Club loans start at $500, so there is certainly more
overlap between the Lending Club and payday loan markets than your
comment suggests. Comparing the APRs wouldn't be the best measure
if we were comparing a payday loan paid off in 1/24th of a year
versus a 3-year Lending Club loan, but there are two reasons why
the comparison is valid: First, your assertion that "the period of
the loan is seldom more than 1/24th of a year" unfortunately is not
true. As I said in my last comment, the report referenced in the
post explains that payday lenders "collect 90 percent of their
revenue from borrowers who cannot pay off their loans when due,
rather than from one-time users dealing with short-term financial
emergencies." Second, Lending Club loans can be repaid at any time
without penalty, so we can either compare APR (as we did) or Cost
of Borrowing (as you suggest), but we should do so on the same
terms. If someone took out a $500 loan from Lending Club and repaid
it within a month, he would only be charged the first month's
interest plus the 1% origination fee. Using the 10% rate assumed in
the original post (actual rates start at 7.88% APR) the Cost of
Borrowing would be 1.83%, which is clearly much lower than the 15%
COB for a payday loan!
I recently read a Reuters news article, written by Nick Carey, Mar
23rd, 8:15pm ET, titled, "’Pay day’ loans exacerbate housing
crisis". I would like to clarify that there are some great
inaccuracies and bias in this story that really must be pointed
out. I have had extensive experience with pay day loans, and,
though I agree that the APR (annual percentage rate) is quite high,
and people can get into trouble when they do not use these loans as
they are designed to be used, this news report highly exhagerates
the cost of a loan. Read from the article as follows; "A pay day
loan is typically for a few hundred dollars, with a term of two
weeks, and an interest rate as high as 800 percent. The average
borrower ends up paying back $793 for a $325 loan, according to the
Center." This is not accurate! And there was much more inaccuracy
than this in the article. A pay day loan from a legitimate
financial retailer generally costs about $15 for every $100 up to
$500. This means that for a loan of $100 for 15 days the charge
will be $15, totalling the loan at $115, which must be quoted as an
APR of 365%. the actual total pay off for a $300 loan is $345. In
reality it is only a fee that is being paid, not interest. However,
government regulations require that it be quoted as interest, as an
APR. The only way that a short-term loan, a pay day loan, could
build up to the absorbitent amount qouted in the news story, is if
the loan were to be "rolled over", which is highly illegal in
nearly every state that regulates these loans, so, thus, it would
be highly improbable that there would be an average of borrowers
that pay such amounts. Pay day loans are for exactly what they are
named. A short term small loan to be paid off by the next pay date
of the borrower. These loans have saved many a borrower, in a
temporary financial pinch, to pay some bill(s), from much harsher
penalties and costs that are incurred by banks and credit
institutions if checks do not clear or payments are late. The
proper use of a pay day loan actually shows a personal and
professional level of responsibility when it is used properly. Yes,
people do mis-use these loans, people get into trouble, people
borrow beyond their means, and there are less than savory lendors
who do not do what is right in order to avoid such disasters for
their borrowers. Pay day lendors must exercise great responsibility
to protect borrowers and potential borrowers from becoming victims
of borrowing beyond their means. That might even mean turning down
a less than able and questionably qualified customer from
borrowing. I am disturbed to also hear lawmakers and politicians
who are buying into mis-information and threaten the reasonable
management and existence of a very useful and helpful service to
many people. Bruce - Washington
Bruce, Please see my comments above in response to Grady, who made
many similar claims to you. If you've had positive experiences with
Payday loans in the past, I am glad that you were able to use them
responsibly. Many others are not so lucky. More than anything else,
many of the people who get abused by payday loans, turn to them out
of lack of understanding and the belief that they have no other
option. Hopefully discussions such as this one will help to spread
awareness of the inherent dangers of using payday loans in a
non-responsible manner as well as inform consumers of much less
expensive alternatives such as p2p loans from Lending Club.
Hat’s off for uncovering the nastiness of this business. Scammers
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