Some short-term loans cost over 20 times more in interest than the average credit card. And yet one in 10 Americans have used them.
These small-dollar advances, or payday loans, are available in most states: All you need to do is walk into a store with a valid ID, proof of income and a bank account. The balance of the loan, along with the “finance charge” (the service fees and interest), is typically due two weeks later, on your next pay day.
In the U.S. today, these loans are a $9 billion business. In the past two years, 11 percent of U.S. adults say they’ve taken out a payday loan, according to a recent survey of approximately 3,700 Americans that CNBC Make It performed in conjunction with Morning Consult.
But while payday loans provide quick cash, the national average annual percentage rate is almost 400 percent. In contrast, the average credit card APR in July was 16.96 percent, according to CreditCards.com.
That can add up fast. For example, if you take out a $500 payday loan with an APR of 391 percent, you’ll owe about $575 two weeks later. The loan cycle rarely stops there, though. Many payday loan borrowers “roll over” the loan multiple times. Do that for just three months and the amount due is over $1,000.
“It’s normal to get caught in a payday loan because that’s the only way the business model works. A lender isn’t profitable until the customer has renewed or re-borrowed the loan somewhere between four and eight times,” Nick Bourke, director of consumer finance at Pew Charitable Trusts, tells CNBC Make It.
Because of the potential financial pitfalls for borrowers, 15 states and the District of Columbia have laws in effect that limit the APR to 36 percent or less, according to the Center for Responsible Lending. But 35 other states are far more lenient. This week, Ohio’s governor signed a new law, which goes into effect in October, that will cap the state’s APR for payday loans at 60 percent.
Ohio currently has the highest payday loan rates in the U.S. with an average interest rate of 667 percent. The average rates in Utah, Texas, Nevada, Idaho and Virginia are nearly as high.
For those who do fall behind on payday loans, the costs can be substantial and long-lasting. Some payday lenders will aggressively attempt recover their money, like by taking it directly from borrowers’ checking accounts, since borrowers grant access as a condition of the loan. These unexpected withdrawals by the lender can leave borrowers subject to pricey overdraft fees and damage their credit scores.
Plus, it can be hard for borrowers to save while paying off such high-cost loans.
“Payday loans are dangerous and unaffordable for everyone, but borrowers who are just starting out or who are struggling financially — they’re the most vulnerable,” Lisa Stifler, the deputy director of state policy for the Center for Responsible Lending, tells CNBC Make It.
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