Payday Lending
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Would you pay 390% for a $400 loan? Most people would say no. Many, however, are saying yes. In the industry of payday loans or cash advances this is just the case. A payday advance or cash advance works like this. A borrower has a need arise, whether from bills or Christmas shopping, and they need a small amount of money. Now, their payday has just past and their credit it less then perfect. They do not have a savings account, and due to their credit they do not have a credit card either. So they stop in to a payday lender. The borrower writes a check for $460, and they get $400 in cash. The $60 is the fee for the loan. The lender gives the loan for 14 days, which is until their next payday. In 14 days the borrower has a couple of options to pay the loan. The borrower can simply do nothing and let the lender deposit the check for cash, or they can go and give the lender cash for the check. However, there is a third option. The borrower can go to the lender, immediately write the lender another check, and extend the loan. This is called “flipping. There are a majority of borrowers who do end up flipping the loan.
Flipping is a major contributor to the down side of payday loans. This is because this allows the person to extend the loan another three or four times. So, initially the fee for the loan is just $60, but if a person flips the loan another four times the fees have gone up to $240. Over the course of a year a person could accrue more than $720 in fees. That is only if they do the flipping 4 times for 3 times a year. Now this does not include the interest rate.
Interest rates for the small loans can be anywhere from 390 to 900 percent, according to Wikipedia. The interest rate for the 14 day loan of $400, with the $60 fee, is 390%. That interest rate is outrageous, especially when a person considers the prime rate is 8.25% (Bloomberg). A person could go the credit union and get a signature loan for just under 13%. Yet, payday lending is still one of the fastest growing businesses. May people believe that is because they prey on the financially uneducated.
A good deal of borrowers is those on fixed income or in the lower income bracket. Their credit worthiness is not go, and they may not have any savings accounts. In fact some may have no financial assets whatsoever. The borrowers are apart of a segment of society that the Center for Responsible Lending have dubbed “unbanked,” According to Payday Lending:Serving the Unbanked by Mike Foley. This segment is primary comprise of the poor. So, when many of these loans are taken out the borrowers can not afford them in the first place. The borrowers only see the small fee for the loan and the fact the company just holds the check, so they see not risk in taking the loan.
Most borrowers do not thing about interest rate or just do not care. They have their wants or needs and that is all they can see at the time. The lenders do not really care if the borrower can pay the loan back. Most of these payday stores are open near or in poor communities. Julian Bond, chairman of the Board of the NAACP said, “visits to day lending stores-which open their doors in low-income communities at a rate equal to Starbucks in affluent ones-are threatening the livelihoods of hard working families and stripping equity form entire communities (Foley). Many borrowers do not perceive a risk in this type of lending, but there is more than one.
The first risk is how easy the lenders make it easy for the borrower to get the advance. They do not do credit checks or background checks. The only thing the borrower needs is a current pay stub and a bank statement. They will have their check in about 10 minutes. The employees also make it easy to flip the loan. When a borrower goes in to pay the loan they will immediately ask if they want to rewrite the check, encouraging another loan.
Another major risk with cash advance is that they can become a habit. The borrower takes out one for $100. Not a big problem. Then, they see something they want, and so they flip the loan into $200. They get what they want, but now the loan is higher, or maybe they have flipped it to many times and now they must pay. So, what other option do they have. The borrower gets another loan from a different lender. The borrower realizes that they can get even more immediate cash by having loans at different lenders. The borrower no longer just has the one loan, but maybe two or three.
In addition to a number of loans they are caught up in a cycle of debt that they can not possible get out of. The borrower may only make $400 every two weeks. That is not enough to pay the loan off and still cover bills and food. They may not have seen a risk on just a simple loan, which has now spiral out of control.
There also may come a time when the person realizes that they will not be able to pay it off so they let the check it their