Payday Lending: How To Avoid The Debt Trap

What is a payday loan?

  • A payday loan offers cash to financially strapped individuals who have a bank account and a job to cover the loan, interest and financing fees
  • These loans amount to $500 or less and you are obligated to repay the amount two weeks after the lending date.

What’s the problem?

  • The payday loan becomes a “debt-trap” when the average borrower realizes that two weeks is not sufficient time to repay the loan.
  • Instead of defaulting, those with payday loans will choose to “roll over” their debt to a new payday loan, with another financing fee and the same high interest rate.
  • Example: If you borrow $500 and repay it in four monthly installments using a payday loan (with a $17.50 per $100 finance fee for a 15-day loan with 7 “rollovers”), you would end up paying $700 in financing fees (an ARP of 426%!) for a total of $1200.

How can I avoid getting trapped with a payday loan?

  • The best way to avoid potentially getting caught in a payday loan debt trap is to have an emergency fund ($500 is a good goal).
  • If you have an emergency fund and need to use it, remember to “pay yourself back” when you receive your next few paychecks.
  • If you do not have an emergency fund you can consider asking a trusted family member, friend, or colleague for a short-term loan.  A written agreement to repay the loan on a specified date (possibly with interest) is essential if you chose to do this.

Are credit unions an alternative?

  • Credit unions, non-profit financial institutions that are owned by the members they serve, are often able to offer cheaper loans to their members.  Their excess revenue is used to benefit members in the form of improved rates and the reduction or elimination of fees.
  • To find a credit union you may be eligible to join in your community contact the National Credit Union Administration online at www.ncua.gov or call the NCUA Customer Assistance Hotline at 1-800-755-1030.

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