Payday loans are a type of short-term loan that can be used to cover unexpected expenses or to avoid more expensive late fees charged by utilities and other creditors. People with little or no credit are often the target customers of payday loans, as they can apply for the loan without worrying about their credit score. Recently, the Consumer Financial Protection Bureau issued a final rule on payday loans, rescinding Obama-era provisions that would have required lenders to ensure that borrowers could repay their loans before issuing cash advances. Most lenders offering payday loans require borrowers to pay a finance charge (service charges and interest) to get the loan, the balance of which is due two weeks later, usually the next payday.
However, taking out a payday loan can have serious consequences for your credit score, savings, and even legal status. A study conducted by the industry-funded Georgetown Credit Research Center found that more than 40% of borrowers believed their payday loan rates were less than 30% APR, which is not much higher than the rate on a credit card. Unfortunately, many customers who use payday loans are unaware of the high interest rates and focus more on so-called commissions. Lawmakers in states with payday loans that want to preserve access to small loans should enact comprehensive reforms such as those in Colorado, Hawaii, Ohio, and Virginia.
But for the vast majority of payday borrowers (those who apply for five or more payday loans per year and account for 91% of all payday loans), these loans function as chronic debt rather than useful credit. In reality, anyone who meets these criteria will probably also have access to some type of credit that is more affordable than a payday loan. Most payday borrowers work this way, either by paying a commission to renew a loan for two more weeks or by applying for new loans, plunging them into a dangerous cycle of debt. People who are most vulnerable to payday lenders often do not have sufficient bank accounts or do not have accounts with major financial institutions, leading them to turn to services such as payday loans to build credit.
But while payday loans can provide much-needed emergency cash, there are dangers you need to be aware of. In addition, the statutes set the duration of a loan, some as short as 10 days, but other states do not impose restrictions on the duration of a loan. According to an industry-funded study conducted by the Georgetown Credit Research Center (CRC), 75% of borrowers interviewed believe that the government should limit the rates charged by payday advance companies, and 72% believe that the government should limit the interest rates that lenders can charge, even if that means fewer consumers could get credit.