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The Payday Loan Trap

Posted by idawrites on June 18, 2008 in Emergency Fund, Finance, Loans |

One of my first lessons in “What Not To Do” with money was actually one of the few lessons that I didn’t learn by trial and error.  I used to work at a Payday Loan call center.  While I have seen a few people who have utilized the service for its intended purpose, the vast majority of borrowers do not.

The Intended Purpose:
To loan small sums of money (between $100 and $1500) to consumers in the event of emergencies that they do not have the funds to cover UNTIL PAYDAY, when the loan and interest should be repaid in full.

The Way It Really Works:
The people who use Payday Loans are very often not in a position to repay the loan in full on their next pay date.  Of the few who are in the position to repay their loans in full on their next pay dates, only about 3% do.

What Happens When They Can’t Repay In Full:
The Payday Loan companies are THRILLED when you can’t repay the loan in full.  Why?  Because they make more money.  They will graciously offer to allow you to “Refinance” the outstanding loan and only pay the finance fee on your pay date.  The catch?  Next payday, you owe the same amount that you did this payday.  The finance fee is, of course, added to the refinanced loan at the same rate as before.  Not only that, but they’ll let you refinance and only pay the fee up to FOUR times.  What a deal, huh?  But wait, there’s more!  Once you’ve reached that 4th time, they won’t make you repay it in full.. no no.. they’ll let you pay it down by $50 and refinance the rest, not once or twice or three times, but as many times as you like.  As long as there is a principle reduction of $50 with each refinance after, you can continue to refinance until it’s paid off.

What This Looks Like In Real Numbers:
The Industry Standard finance fee is $25 for hundred dollars borrowed.  That’s not as horrible as it sounds, given that if you borrow $100 to keep a check from bouncing, you’re saving yourself $63ish in bounced check fees (for one check).  But anything beyond that, gets ugly.

 $300 Payday Loan   Fees   $500 Payday Loan   Fees   $1500 Payday Loan   Fees 
 $ 300.00  $  75.00  $ 500.00  $125.00  $1,500.00  $375.00
 $ 300.00  $  75.00  $ 500.00  $125.00  $1,500.00  $375.00
 $ 300.00  $  75.00  $ 500.00  $125.00  $1,500.00  $375.00
 $ 300.00  $  75.00  $ 500.00  $125.00  $1,500.00  $375.00
 $ 300.00  $  75.00  $ 500.00  $125.00  $1,500.00  $375.00
 $ 250.00  $  62.50  $ 450.00  $112.50  $1,450.00  $362.50
 $ 200.00  $  50.00  $ 400.00  $100.00  $1,400.00  $350.00
 $ 150.00  $  37.50  $ 350.00  $  87.50  $1,350.00  $337.50
 $ 100.00  $  25.00  $ 300.00  $  75.00  $1,300.00  $325.00
 $   50.00  $  12.50  $ 250.00  $  62.50  $1,250.00  $312.50
 $ 200.00  $  50.00  $1,200.00  $300.00
 $ 150.00  $  37.50  $1,150.00  $287.50
 $ 100.00  $  25.00  $1,100.00  $275.00
 $   50.00  $  12.50  $1,050.00  $262.50
 $1,000.00  $250.00
 $   950.00  $237.50
 $   900.00  $225.00
 $   850.00  $212.50
 $   800.00  $200.00
 $   750.00  $187.50
 $   700.00  $175.00
 $   650.00  $162.50
 $   600.00  $150.00
 $   550.00  $137.50
 $   500.00  $125.00
 $   450.00  $112.50
 $   400.00  $100.00
 $   350.00  $  87.50
 $   300.00  $  75.00
 $   250.00  $  62.50
 $   200.00  $  50.00
 $   150.00  $  37.50
 $   100.00  $  25.00
 $     50.00  $  12.50

Total principal plus finance fees paid for stretching payday loans out as far as the companies will let you:

Borrowed Repaid
 $    300.00  $   862.50
 $    500.00  $1,687.50
 $ 1,500.00  $8,812.50

You don’t have to be a math major to figure out that this is a bad idea.  Sadly, the payday loan companies build their businesses based on one assumption… 75% of all borrowers will refinance the maximum amount.  Often times, I’ve seen bank statements from customers who have 3 or 4 payday loans at one time.  They borrow from one payday lender to pay the last ones their finance fees because they can’t afford to pay off the first one.

It’s important to note, that the average individual (not household) income for a payday loan borrower is between $30,000 and $120,000 per year.  One other interesting tidbit, the television ads for these services run during the day, between 12:00 and 3:00 PM.  They’re putting ads on Maury and between your soap operas.. guess who their target demographic is?  Women between the ages of 18 and 35, who control the household finances.

Don’t get caught in the Payday Loan trap.  It’s not worth it in the long run.  This is one of the more serious examples of why an emergency fund is a must-have for everyone.

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