Avoiding the Payday Lending Trap
Payday loans are cash loans that are granted for a very short time frame – typically until the borrower’s next payday. The borrower writes a postdated check payable to the lender for the amount borrowed plus a fee and receives the needed cash in return. The lender holds the check until the next payday when the loan and the fee must be paid in one lump sum. To repay the loan, a borrower can redeem the check for cash, allow the check to be deposited, or pay another fee to roll the loan over for another pay period.
Why are Payday loans not a good financial option?
The fee charged for a payday loan typically ranges from $15 to $30 for each $100 borrowed. For a two-week loan, the fees result in an Annual Percentage Rage (APR) of 390% to 780%. If the loan is rolled over and not paid after the initial payment period, the interest rate climbs even higher (99% of payday loan borrowers roll over their first loan). Because of these fees, many payday loan borrowers find themselves trapped in a cycle of debt. Here’s how the payday loan cycle works:
- Sallie needs a loan of $250 to cover expenses until her next payday.
- She writes the payday lender a post dated check for $340 to cover the loan and a $90 fee ($30 per $100 borrowed). She receives the $250 in cash.
- At the end of two weeks, Sallie is unable to pay back the $340 she owes. This amount is rolled over into a new loan and an additional fee of $90 is charged.
- Sallie now owes $430 and she has paid $180 to borrow $250 for one month.
- If she cannot pay back the $430 at the end of the month, Sallie has no choice but to roll over the loan again and incur another $90 fee. This rolling over of debt is how the Payday loan debt cycle gets started.
What are some alternatives to Payday Loans?
The best alternative to a payday loan is to establish an emergency savings account of at least $500. Once established, this emergency account can be tapped when unexpected expenses cause a shortfall between pay periods. Setting aside funds from income tax refunds or having a small amount automatically deducted from your paycheck is the easiest way to set aside money for a rainy day. There are other alternatives that are less costly than a payday loan:
- Apply for a less costly loan – Andrews Federal’s Cash-To-Go Loan provides a lower cost alternative to a payday loan.
- Decrease Expenses – take a hard look at your expenses each pay period. The best way to do this is to write down and review every expense for a period of 2 – 4 weeks to determine ways to reduce overall expenses.
- Work Overtime or Pick Up Extra Work - If you cannot decrease your expenses, then look for ways to increase your income. Selling something of value that you no longer need is another way to temporarily increase your income to make it through a cash shortage.
- Adjust Taxes Withholdings – If you typically receive a large refund at tax time, it might be worth looking at the taxes withheld from your paycheck each pay period. By changing your withholding, you can increase the amount received each paycheck instead of over-withholding every payday and getting a big refund later.
- Apply for Overdraft Protection on Your Checking Account – Funds can be automatically transferred from an Andrews Federal overdraft line of credit to cover checks or debit card transactions that overdraft your account. While you pay interest with overdraft protection, it is less expensive than borrowing from a payday lender or paying a returned check fee at a financial institution and at a retailer.
- Advance Cash from Your Credit Card – This is probably the least preferred alternative but still cheaper than a payday loan. Bank or credit union credit card cash advances typically run less than 21% APR. While some are higher, none come close to the 458% APR in the payday loan example shown above.
Breaking the Payday Loan Cycle
Getting out of a payday loan cycle takes a lot of effort. Here are some tips that can help:
Analyze your current financial situation
- Stop unnecessary spending – Don’t add any new debt to the amount outstanding. If you have to cut up your credit cards to avoid spending money, then do it!
- Analyze your expenses - Track where your money goes for two to four weeks. Write down every penny you spend. Once you have tracked expenses, take a look at where you can cut costs. Are you paying for unused features on your cell phone or land line? Can you switch to a cheaper cable channel package with a few less channels? If you try hard, you will be able to come up with areas where you can reduce or even eliminate expenses.
- Review your debt – List all you debts, then set priorities for repayment. The extra money that found when you analyzed your expenses should be used to make additional payments on your higher rate debt.
- Start an emergency savings account – Use a portion of the liberated funds above to start an emergency savings account. Start small and raise the amount you save as your financial situation begins to improve. Saving as little as a $10 a week will provide you with over $500 emergency savings at the end of the year.
- Set realistic financial goals – Write down reasonable and attainable goals that you want reach in the short term (less than 1 year), medium term (2-5 years), and long-term (over 5 years). Determine how much money you need to save each pay period to reach this goal. If you do not have an emergency savings account, this should be your first short term goal. If you need to pay down debt, make this another goal and pay off the highest rate debt first.
- Understand the root of the problem – Are you spending beyond your means because your income is insufficient to live on or because you’re spending more than you need to on non-necessities? Everyone would like to earn more but is this really the problem?
Seek help when you need it
- Financial information – For tips on managing your money or interactive tools that guide you through the budgeting process, visit additional sections of the online Education Center to find out more.
- Free and confidential counseling - Contacting a financial counselor can really help you focus on your financial issues. Contact our in-house financial counselor at 301.702.5514 for budgeting and credit assistance. A financial fitness program called BALANCE is also available to you as a benefit of Andrews Federal membership. A financial counselor will review your current debts and suggest ways to reduce your expenses. They can also assist you in developing a spending plan that gets you out of the payday loan cycle. For a phone consultation, call 888.456.2227, or 0.800.187.5305 (Outside U.S.).