Next time you drive around town, count the number of payday lenders you see. Signs for title loans are likely to pop up every other block. If you have never used a payday loan before, then you might be as ignorant as I was about how they operate.
The Pew Charitable Trusts recently released its report "Payday Lending in America: Who Borrows, Where They Borrow, and Why." According to the study, approximately 12 million Americans have used a payday loan in the past year. You might have seen commercials advertising payday loans as short-term loans designed to free you from an unexpected or emergency financial situation. The reality, however, is that seven out of ten borrowers are using the loan to pay for recurring expenses, such as rent, utilities and other monthly bills rather than for unexpected or emergency expenses. Furthermore, because of the way payday loans are designed, most borrowers end up having to take out or renew a loan eight times a year on average. Let me explain how this works:
First, let's take a look at the scenario of one person – let's call her Betty Borrower. She is part of the demographic most likely to be a payday borrower: she's African American (African Americans are 105 times more likely to use payday lending compared to other ethnic groups), 28 years old, divorced, making under $25,000 a year, never graduated college and rents an apartment. Betty didn't budget very well this month and she has come up short on funds just before her car payment is due. She remembered seeing that fast, quick, easy loan place just down the street, so she headed there, passing a few other payday lending retailers along the way. In no time, she walks out of the payday lender’s store with $375 for her car payment – Whew, just in time!
Two weeks roll by and it's time to repay her loan. Betty owes the $375, plus $56.25 in interest. The bind Betty has put herself into is compounding. Because of the payday loan, her car payment went from $375 to $431.25 in the course of a month. Now she's coming up short for her rent, so she has to renew that loan – and the vicious cycle begins. As I mentioned previously, the average borrower will go through this cycle eight times each year. If and when Betty Borrower is finally able to pay off the loan and interest without having to seek out an additional loan just to make ends meet, she will have paid $520 in interest on a $375 loan in the course of one year! For anyone curious, that's 391% APR; and yes, this is entirely legal in 28 states, including Texas.
Let the buyer beware, caveat emptor? Maybe, but think about how these payday loans are marketed and then put yourself in Betty's shoes. The payday lender looks like the good guy helping you out in a tight crunch with some quick cash. It's not designed to be a recurring loan-term loan – or is it?
If you pay attention to any payday lending advertisement, you'll walk away with the impression that it's a short-term loan, there for the unexpected and emergency situations. In reality, payday loans are unprofitable unless a borrower takes out or renews the loan four or five times in a year. If you're able to pay that loan back in two weeks, the payday lender loses money – a disincentive that can become a basis for unethical practices.
Now, for those of you ready to stand out in front of your community's nearest payday lending retailer with a picket sign and bullhorn, I'm with you. If you feel like payday lending is predatory and unethical, then you're right, and please make your voice heard.
As a business development specialist working with small business owners in Austin, I'm concerned about the prevalence of these types of lenders in my state and within the Austin community. One of the main roadblocks to realizing a business dream is the overwhelming burden of personal debt.
Limits and restrictions on payday lending retailers can and do make a difference. You might think, as I did, that if payday lending retailers aren’t available, a borrower will simply go online and get a loan. Yes, that's true, they can easily go online for a loan, but the PewTrusts' study shows that borrowers are actually unlikely to use online lenders in place of storefront locations. In fact, if 20 people intended to borrow from a storefront payday lender and the retail location suddenly became unavailable, only one would continue to seek alternative loans, including from online sources. The other 19 would seek non-lending alternatives such as: re-budgeting, prioritizing bills, pawning off or selling belongings, borrowing from family or friends, or even working out a payment plan with bill collectors. Many of these alternatives are pro-active and can be effective. Yet, according to a recent article in the Texas Tribune, Texas had approximately 3,500 payday lending retailers in 2010, double the amount that existed only four years earlier.
As an AmeriCorps VISTA at Foundation Communities, a non-profit in Austin, I worked with their Financial Coaching Program, where free one-on-one financial coaching is offered in a structured environment, focusing a lot on these proactive alternatives. If you or someone you know is having trouble making ends meet or is considering taking out a payday loan, please don't – take an hour with one of these coaches first and see if there are any alternatives to payday lending – don't get stuck in the vicious cycle of payday loans. The incentives for current payday lending practices are well established and ingrained, We have experienced the unfortunate consequences of predatory lending on our economy and we need to question the legality and ethics of these practices, even at the micro level of payday lending. Until reform happens, I encourage you to be an advocate against current practices and educate as many people as you can about the true consequences of payday lending.