Posted by Mike Smith :: 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.
7 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.
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