Payday loans have made media headlines around the world. This short-term type of borrowing generates debate and receives ample criticism. The concern surrounds the fact that they’re targeted at and popularly used by people living paycheck to paycheck.
Indeed, many payday borrowers learn firsthand why there’s controversy. In the UK last year, complaints to the financial ombudsman about payday loans rose to almost 200 a week. In the second half of 2016 that meant a total of 5,095 complaints — 22% higher than the beginning of the year. And this was despite the country’s regulatory clampdown on the industry. The ombudsman service admits the jump partly reflects people’s growing awareness of their rights.
Nonetheless, there seems to be no slowdown in the numbers of people turning to this form of loan. So, for some people there are obviously advantages. What follows is a summary of the top pros and cons.
Among the most obvious advantages of payday loans is that they can be for amounts as small as $100. This lets people, who are a little short to pay the rent or get an unexpected car repair, borrow only what they need.
Fast and easy
Precisely because they’re designed as a go-to source for people in a bind, the application process is simple and quick. In countries like the US, the quick factor is aided by convenience. Payday lender shops abound in neighborhoods that are home to their target demographic. There are reportedly more payday loan stores than McDonald’s restaurants. Worldwide people are even starting to snap up short-term debt while dressed only in pajamas. Online small-dollar lending too is a growing segment of the short-term lending market.
Credit score irrelevant and unblemished
Another major appeal to payday loans is that anyone’s chances of being approved are pretty good. And that is especially good news for folks with a bad credit score. Based on analysis of a person’s credit files, credit scoring is used in many countries to represent a person’s ‘creditworthiness’. But payday loan shops don’t do the type of credit check that traditional lenders do to evaluate the risk they’re taking by lending you money. This means that a person’s past credit problems won’t stop them getting cash from a payday lender.
A related advantage is that a standard credit inquiry would’ve shown up on the borrower’s credit record, impacting their score. That’s because signs that you are applying for new credit makes you appear less likely to handle your existing debt. (Some countries don’t use credit record/score systems but instead use ‘blacklist’ type registers to log people analyzed as uncreditworthy.)
A final plus here, according to the Norwegian loan provider Billigeforbrukslån.no, is that if a payday borrower can’t pay off the loan on their next pay date, their credit score won’t suffer.
No collateral needed
Also unlike most other lenders, payday providers don’t care if you have any assets or credit cards. For this type of ‘unsecured’ loan, a borrower needs only to prove that they have a source of income and a checking account. It isn’t even necessary that your account balance be enough to cover the post-dated check (or debit preauthorization) you give the lender.
Saves higher fees
Finally, another possible advantage kicks in only if the loan is repaid on the original due date and not ‘rolled over’, which costs another fee each time. If paid off on the short-term as intended, payday loans can cost less than hefty charges for a bounced check.
So, yes, payday loans help when you have an expense that needs to be put off for a short time. However taking a short-term high interest loan that is due in one single payment can have big disadvantages and risks.
Unclear fee structure
Unfortunately, many payday borrowers are unable to pay their loan with its fees in full when it’s due. This can of course be contrary to the scenario the borrower imagined when they took out the loan. If they anticipated having a healthier cash flow, or they trusted an unscrupulous lender, a payday borrower is often unaware of the expense they’re in for.
Payday lenders aren’t known for their transparency. In fact, in many places their advertising practices are the source of government scrutiny and legislation. This is often because they avoid comparing their rates to those of mainstream lenders, which use an annual percentage rate (APR).
For example, say a payday lender charges $17.50 per $100 borrowed. On a 10-day loan, that equals an effective APR of nearly 640%. That is 15 times more than some of the most expensive credit card default rates.
Huge fee burden
If their next pay comes around and a payday borrower’s pocketbook is still too lean, it’s a bit too easy to extend the loan. Also known as “rolling over” the debt, this costs another fee and allows you to keep the loan for another period. You’re charged a fee each time you roll over the loan.
Some jurisdictions don’t allow or limit rollovers but will let you take back-to-back loans. Some are instituting a mandatory “cooling off period” (triggered after a certain number of repeat loans).
However, surveys have found that it is common for desperate borrowers to find themselves getting cash from one or multiple payday stores to pay off another payday debt.
This is how things can spiral into a big debt hole that is hard to climb out of. If a borrower starts using short-term debt to cover chronic cash flow shortages, the costs quickly overshoot the amount borrowed. A 2008 issue brief from the US nonprofit Center for Responsible Lending said the typical payday loan borrower ultimately has to pay $800 for a $300 loan.
Even a US payday loan industry-sponsored report found a considerable percentage of payday borrowers used payday loans frequently. This left them owing payday debt in over half of the year, though not necessarily continuously.
A 2007 Center for Responsible Lending report had numbers on that phenomenon. More than 60% of payday loans were taken by people who had at least 12 payday loan transactions annually. Nearly one-quarter were withdrawn by customers who had at least 21 payday loan transactions annually.
Regulation not adequate
Ultimately, since the payday loan model is so profitable to companies, they find loopholes to keep the industry thriving. This means that it is much more than a “buyer beware” matter. Payday borrowers ought to remember that, despite the strategy of employing ultra-friendly and welcoming employees, this type of business is purely about profit.
“To say that the short-term loan industry is resilient, creative, and resistant to piecemeal legislation is a tremendous understatement,” notes US one law expert. “The amount of legislative time and effort the industry’s shifting business plans have spawned is nothing short of remarkable.”