Payday Lenders are Disastrous to Your Finances
By David Dierking
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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