Americans spend more than $7.4 billion on payday loans every year. That’s hardly peanuts, especially when you consider that these billions are earned $50 to $100 at a time, often off the backs of the Americans who can least afford to part with their hard-earned cash.
For the uninitiated, payday loans — also known as payroll or direct-deposit advances — work like this: A borrower promises to pay a fee, generally in the neighborhood of $15 per $100 borrowed, until their next paycheck arrives. On payday, the lender will claim the fee plus the original amount borrowed. That’s how it works in theory, at least. But many borrowers can’t afford the lump sum payment, so they roll over the original loan, plus the original fee plus a new fee, which is higher than the initial fee because the borrower owes both the principal plus that fee at this point.
The average payday loan is for $375 — and the average borrower ends up saddled with that debt for five months, during which time they pay $520 in interest. When research group the Pew Center on the States released a payday lending report, part of its Safe Small-Dollar Loans Research Project, it discovered these and other sobering facts.
One of the big questions the study set out to address is whether the way payday lenders present their products — as a quick, hassle-free way to get cash for a week or two when an unexpected expense crops up — reflects the kind of experience people actually have with these loans. Are they a quick stopgap, or are they a pricey band-aid solution to chronic financial problems that compound the problem they purport to solve by charging what amounts to triple-digit interest rates?
Nearly 70% of payday loan users say they use this money for everyday expenses, and only 16% use the funds to cover an emergency or unexpected expense. Disturbingly, 5% of people report taking out payday loans to buy food. That’s pretty much the opposite of an unexpected expense.
Pew researchers throw cold water on the idea that payday loans are a quick fix. Although the term of these loans is generally in the two-week neighborhood, the average borrower is on the hook for five months. During this time, the fees keep adding to the unpaid balance, making it even harder for the borrower to come up with the cash to pay off the debt.
The report also debunks the perception that only the most hard-up, desperate Americans turn to payday lenders. More than 5% of the population, or 12 million people, use these products every year. “People of most ages and incomes use payday loans,” it says. More than 40% of borrowers own their own homes, and a little more than a quarter of them make more than $40,000 a year.
Although white women between the ages of 25 and 44 are the most frequent customers of payday lenders, a look at the percentages shows that some groups bear much more of the brunt of payday lending relative to their population size. African-Americans, the disabled, those without a college degree and people who are separated or divorced are more likely to take out payday loans, the report finds.
Whether or not you’re likely to take out a payday loan depends a lot on where you live; researchers found that residents of states with lax regulation of the payday lending industry are more likely to borrow this way. In states that have implemented the toughest laws limiting the interest and duration of these loans, 95% of would-be borrowers don’t take out payday loans; only 5% go online or elsewhere to get a short-term loan.
The lending industry argues that limiting the number of “rollovers” a borrower can conduct keeps people from cash they need immediately and can’t get any other way. But that’s not really true; when Pew researchers asked payday loan users what they would do if they ran short of cash and couldn’t get a payday loan, more than 80% simply said they’d cut down on other expenses.
Months of being saddled with a debt racking up the equivalent of 300% or 400% APR versus a week or two of belt-tightening — this new research spells out rather clearly which choice is better over the long run.