Payday Lenders are Disastrous to Your Finances

In this age of 24 hour news, TMZ and Twitter, there’s not much that surprises me any more. It seems more and more like the ridiculous is becoming the norm. Yet, every once in a while I read something that manages to catch me off guard. I came across one such nugget this past week.

The FDIC published a report recently that says more than one in four American households, including more than half of black households, use check cashers, payday lenders or pawnbrokers rather than a bank.

I was floored when I read this. I knew that places like Check ‘N Go were more popular with lower income individuals but more than a quarter of all households use them instead of banks including more than half in the black community? That seems like an extraordinarily large number. I had thought of writing about the downside of using payday lenders in the past but ultimately decided against it because I figured I’d only be speaking to a small population. Clearly, I was wrong.

I’m not sure that the individuals that use payday loans on a regular basis are the same ones that visit a personal finance website such as this but since the number is considerable I’m counting on at least a few of you being here. And to you, let me make my message perfectly clear – payday lenders are bad news for your money.

Payday lenders provide short-term loans (typically up to about two weeks or when you receive your next paycheck) and charge a fee that gets paid back along with the principal. I visited the Check ‘N Go website to look at rates in Wisconsin (the state I reside in) and found that Check ‘No Go charges a 25% fee for loans taken online for up to $1000. That translates to an annual percentage rate of 651% (compared to rates of 25-30% on a credit card, about 8% on a home equity loan, or 8% at Lending Club for borrowers with excellent credit).

It seems obvious to say that getting money from a place that charges an annual percentage rate of 600% or more on a loan is a bad idea but there are a number of reasons why you should avoid these establishments under any circumstances.

The first obviously is the cost. Using my example above, even if I were to take a loan of just $200 that would cost me $50. Do that twice a month and that’s an extra $100 a month out the window. Wouldn’t that money be better used going into a savings account? Throwing away money like that it’s no wonder people need a loan just to get to the next paycheck.

Another is your credit history. How would a person generate any kind of good credit history if they don’t have an established bank relationship and need a loan at 600% just to make it to the next paycheck? This will make it exceptionally difficult to get a mortgage even under the best circumstances.

If you’re one of the thousands of regular users of payday lenders, here’s a simple three-step plan to break the cycle.

1. Put That Paycheck in a Bank Checking Account

Instead of dropping hundreds of dollars needlessly at a payday lender, open a no-fee checking account online or at a local bank (many of the big banks have them) and deposit that check for free. Enjoy the benefit of having your money federally insured while helping to keep creditors off your back!

2. Build an emergency fund

Take the money that you would have used on loan fees and put it in a savings account. Odds are that the money you were spending on payday loans will start building up quite quickly for yourself instead.

3. Get a Copy of Your Credit Report

There’s no telling what your credit report might say if you’ve made a number of payday loans especially if you’ve defaulted on one of them. Go to www.annualcreditreport.com to download yours (you’re entitled to one free copy per year) and see if anything looks fishy or needs to be fixed.

Breaking the vicious cycle of needing a payday loan every two weeks to make ends meet can be a difficult one to break but the rewards for doing so are well worth it. It can mean your first real steps on the road to financial independence and more money in your pocket.

And in today’s economy, you may see no greater return on your money!

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Author Info

This post was written by David Dierking. David lives outside Milwaukee, Wisconsin and has been working in the financial services industry for over 13 years with a background in investments, accounting, and marketing. He earned his Chartered Financial Analyst designation from the CFA Institute in 2004 and was recently published in the Milwaukee Business Journal. You can also check him out at The Ultimate Fit Challenge

11 Responses to “Payday Lenders are Disastrous to Your Finances”

  1. Edwin |  Dec 22, 2009 at 8:44 pm

    I remember reading that a big part of why minority groups tend to use these services more often is the unavailability of real banks or credit unions in poor, urban neighborhoods. They just don’t have a place to go to without a lot of effort and people who may be poor and less educated tend to not understand the impact check cashing and payday loan places have on their money.

  2. Alex |  Dec 23, 2009 at 8:56 am

    In Los Angeles, radio programs cover this topic and the majority of callers who use payday lenders and check cashing services say how fed up they were with banks charging high fees for overdrafts (especially with ATM use) that they quit using banks all together. The problem, as I see it, is one of education. Without a quality education that includes math and english proficiency, how can a person understand the terms of a bank account agreement, how to balance a checkbook, or the pitfalls of financial decisions like using an ATM card to pay for goods. The majority of the callers actually preferred these predatory institutions and saw the banks as the snakes in the grass.

  3. J Kursman |  Dec 23, 2009 at 12:18 pm

    As the Public Relations Director for Check ‘n Go, let me clarify a few of the points made in your posting.

    1.) Check ‘n Go’s customers, and the 19 Million Americans who utilize payday loans and cash advances annually, represent every socio-economic, ethnic and religious demographic on the spectrum.

    As a matter of fact, our “average customer” is truly the “average American”…both men and women, 25-49, all races and nationalities, avg. annual income of $42,000-45,000, 40% are homeowners, 61% or more with some college education…etc.

    Millions of Americans utilize payday loans because at a fee of $0.15-$0.25 per $1.00 borrowed for 14 days, our loans are 1/3 to 1/5 the $0.75 per $1.00 loaned for 3-4 days by banks and credit unions in the form of “overdraft protection”. According to a 2008 FDIC study, the average overdraft fee was $27 on an average overdraft of $36.

    The author cites the APR of a two-week product as the rationale for his argument, but the APR on a $100 ATM transaction from a “foreign bank” is close to 1,500%. That’s to take your own money out of your own account!

    The world would truly be wonderful if everyone had the capacity to always live within their financial needs….to never have to borrow money, but it simply isn’t realistic.

    The vast majority of Americans live paycheck to paycheck and 30% or more don’t qualify for credit cards and other more traditional financial products…

    These educated customers use payday loans to cover auto repairs, dental and vet bills and other unplanned expenses or to on occassion, provide food, clothing and a roof over the heads of their families vs . paying more in late fees, overdrafts, etc.

    Where allowable under statute, Check ‘n Go and others offer Extended Payment Plan options to customer once a year at no cost, extending payment periods from 2 to 8 weeks.

    We also advise customers to borrow less on a successive visit if the remainder of their paycheck doesn’t quite cover their regular bills.

    What would you have these customers do? Banks and credit unions are not meeting the needs of these consumers and the FDIC’s own small loan alternative program had just of 8,000 users in 1 year…not quite covering the demand!

    The fact that 30% of Americans occassionally choose to use an alternative to a bank or credit union is not a negative…its educated consumer choice!Until you’ve lived in their shoes…it’s condescending stand in judgement! These consumers are a lot more educated and savvy than you give them credit for!

  4. David Dierking |  Dec 23, 2009 at 4:24 pm

    Mr. Kursman,

    Let me address each of the points you made in your response – both the ones I agree with and the ones I disagree with.

    Let me concede this point right off the bat. Payday lenders like Check ‘n Go serve a very real market segment that exists today. There are consumers out there that are frustrated with the current banking system and see “alternate financial services” as a better option. For those that feel this way and are willing to pay the fees associated with payday loans and cash advances, Check ‘n Go has every right to serve and build a business model around these customers.

    But I will not concede that this is the “best” way to manage your finances.

    Re: the “average” customer…While I have no doubt that Check ‘n Go’s customers represent virtually all demographics, studies show that the primary sources of business for payday lenders are lower income minorities (including the FDIC report I cite). Many of them are young, less educated and as you suggest simply living from paycheck to paycheck.

    Re: payday loan fees vs. bank overdraft/ATM fees…Just because a bank will charge a fee for certain behavior doesn’t mean that the consumer has to put themselves in the position of having to pay them. What ever happened to not spending more than what you have? How about not overdrafting the account in the first place? Yes, banks do charge exorbitant fees for certain transactions but consumers can be smart too. My bank has a branch just a short distance from my house. I use the ATM there and never pay a fee. There are ways to make it work.

    My bank charges $39 for an overdraft. Using the example from the article, if I were to borrow $200 at 25% for two weeks (which is the rate for my state – Wisconsin), I’m paying $50 in fees. That’s more expensive than an overdraft and if I’m using this money to pay for auto repairs, medical bills, or housing as you suggest, $200 isn’t going to get me very far and I’ll likely be paying even more for a larger line of credit.

    While many Check ‘n Go customers may feel disenfranchised by traditional banks, I can’t believe that regularly using payday lenders makes more financial sense than opening a low minimum free checking account at a bank and NOT overdrafting it. As I suggested, use the money you would have spent in payday loan fees and put it in a savings account and suddenly you have a cushion to fall back on in case some of those unexpected expenses arise.

    I disagree with your assessment of my judgement as “condescending”. I would agree that many people have a much more difficult time making ends meet than I do but my goal is to advocate for the best ways for these individuals to improve their financial situation and I can’t in good conscience advocate for consumers spending such large amounts of money in fees when they can be avoided.

    • Edwin |  Dec 23, 2009 at 5:57 pm

      David, one thing I have to disagree with in your reply is that they serve a real market segment. The only way I see them serving a market segment is if you define that segment as poor, uneducated, confused, and MISINFORMED when it comes to their personal finances.

      Sure people are frustrated with traditional banks (I happen to be one of them). But dealing with that frustration doesn’t mean you should just throw even more of your money away to another scammy company (read: payday lenders).

  5. Edwin |  Dec 23, 2009 at 5:26 pm

    J Kursman, that’s about the level of miss-information I would expect from you guys.

    First off, an average is 1 number, not a range. Second, I expect your demographic information to be skewed (probably using each person who has applies for at least 1 payday loan rather than weighing people who rotate them).

    Comparing yourselves to overdraft protection is ludicrous. Overdraft protection is already a horrible rip-off and is being addressed by legislation. How about we take a look at payday loans vs. credit cards (because after all, everyone knows credit cards charge nasty rates).

    Credit cards can charge up to 35% APR, pretty high. Payday lenders charge anywhere from a low of 400% to a high of 800%, that’s robbery.

    Using payday loans is not an educated choice whatsoever. Your companies push your “services” with massive marketing campaigns that overwhelm any sense of what their best options are. You deliberately attempt to hide the alternatives, which are far better, and come spouting your fake “statistics” and other marketing bullshit so you can continue tricking people into your fee laden theft rings.

  6. Andy |  Jan 01, 2010 at 9:05 pm

    “For every complex problem there is a simple solution. And it’s always wrong. ”
    H.L. Mencken.

    Not only did you provide a truly oversimplified solution to something that is actually complicated in nature, you positioned yourself from the vantage of being intellectually superior to anyone who has ever “fallen” for the trap.

    I can agree with your main premise that spending an extra hundred a month for payday loans that in theory could be going into a savings account. But, in practice life is often more complicated.
    It appears to me that you are lumping too many people across a broad range of socioeconomic status into the same category: obviously stupid.

    So, the best advice for those of us you think are obviously too stupid to not pay attention to the extortionist rates of a payday loan company is to put our money in a bank account and check our credit report? COME ON NOW! REALLY? I think you missed the fundamental purpose of a loan. The borrower lacks said funds to cover an expense. Therefore, he can’t just put his future money in the bank and tell whatever pressing financial burden du jour to wait. He needs money now. Tell that minimum wage earner that his daughter doesn’t need to eat three times a day or the young mother who’s infant is chronically sick to not pay her after-insurance medical bills or that young professional with a significant student loan burden to just hold off on fixing her car.

    The solution to the problem is good credit, but the irony of the situation is that the very banks whom you would curry favor with through good credit are the very same institutions seeding money to the paycheck lending industry. Look it up, the biggest ones are publicly traded. Who owns most of their stock? Wait for it……other traditional banks.

  7. Flxiblemetro |  Jan 02, 2010 at 6:44 pm

    Hello everyone,

    Out here in San Franciso, CA; six credit unions parthered with the city will take on payday lenders.
    If you have about 40 minutes of your time, please watch and listen the video on the following link below:
    http://www.newamerica.net/events/2009/springing_the_debt_trap