Thursday, September 25, 2008

Payday Loans: Loans That Just Don't Pay to Get

Here's a great article about Payday loans from a Navy Knowledge Online posting of a Lieutenant Nuzzo. This is essentially Nuzzo's article verbatim with exception to the removal of several phone numbers. This article is useful to non-military also.

Payday loans. Cash advance loans. Deferred-deposit check loans. Postdated check loans. Within miles outside the gates of any military installation you are sure to find institutions making these offers to service members who they know will some day look for a quick answer to their financial woes.

But quick convenience often comes at a long-term price.

The search for such quick loans can, and often does, lead to spiraling problems that end up with a visit to the Legal Service Office, a financial consultant, or worse. In addition to all the credit related problems faced in the civilian world, service members must also consider the impact of their financial responsibility on their careers. Creditors might seek to involve a command, obtain a garnishment of wages or other practices that may eventually cause the loss of a required security clearance.

And these are just a few of the considerations.

The good news is that these problems can be avoided when you, the consumer, educate yourself and plan for unforeseen pitfalls that lie ahead.

Legitimately run pawnshops, check cashers, convenience stores and even some Internet companies offer a variety of loans that can go by a variety of names, but which all work in essentially the same way. Typically, a borrower will write a personal check payable to a lender for which they receive cash. The amount of the check is normally for the amount the borrower receives, plus a lending fee. From here the process can work in a variety of ways. Some lenders may hold the check until the member’s payday and then automatically deposit it. Other lenders may require the borrower to return to pay them - in cash - an amount equal to the total, in exchange for the check.

Lenders always allow borrowers to extend their pay off time by “rolling over” the loan. This is a huge benefit to the lender because they merely extend the amount of time in which the loan can be paid off in exchange for another lending fee. Essentially, the lender makes more money off the borrower without taking on any more risk by lending more money out. This way the lender gets more money for doing nothing more than it already had done. The rollover is invariably a very profitable win-win situation for the lender.

Let’s consider a brief example of this process in action: A borrower needs to borrow an amount, let’s say $100.00. An average finance charge payday loan lenders charge for a two-week loan on this amount is around $15.00. When this amount is converted into an annual percentage rate (APR), this loan is being given at a staggering 391% rate. Compare this to the rates of 7 to 20 percent consumers find with most credit cards (even high interest rate ones). Now, if the consumer rolls over the amount for just one period, the finance fee doubles. Borrowers can quickly find themselves facing 400%, 500% or even 1,000% APRs on the amounts they borrow. Put another way, rolling over this finance charge just three times in just over one month’s time –six weeks – would cost a borrower $60 to borrow the $100.00.

Couple these interest rates with bounced check fees and other penalties that both the lender and your financial institution can charge, and the potential costs of payday loans really start adding up. Additionally, lenders normally threaten late borrowers with criminal prosecution for writing bad, or “hot,” checks, which they may legally pursue even if they knew you wouldn’t be able to repay the money when they lent it to you. Often, a borrower will find themselves getting sucked into the quicksand of rolling over their loans and fighting just to pay the loan fees.

There are several practical ways to combat the payday loan problem, and everyone can do it.

- Shop for the credit you accept. Research potential lenders through the Better Business Bureau online (www.bbb.org) to see what their consumer track record is like. Pay close attention to APRs. While a percentage point or two does not seem like a lot of money, over the long term it adds up to hundreds, if not thousands of dollars. For example, a five year loan of $5,000 at 9.5% racks up $1,300.56 in interest over the life of the loan. The same loan at 7.9% accrues on $1,068.57 in interest, a savings of nearly $250. Free online interest calculators are available at sites such as www.bankrate.com and other websites.
Also, ask the lender you choose whether there are fees or penalties for early payoffs. These fees can be just as damaging as a high interest rate but remain hidden until you attempt to pay off the loan early.

- Develop a debt repayment plan with a free consumer credit counseling service. Often these programs are available at little or no cost through your bank, credit union or housing authority. Consumers may find services like this online, too. Be very cautious with what you find on the Internet, though. Don’t jump at the first one or two you come across. Research them. You should be careful in selecting these organizations, as you should be with any company which directly affects your credit.

- Call your existing creditors and ask if they can work with you to lower your payments. Most creditors are willing to discuss making adjusted payments in times of hardship and may do so with a minimal finance charge or possible no cost. You may be surprised to find that a one-month late fee on your credit card is actually less than the interest of a payday loan. Be careful though, some loaning agencies may have an acceleration clause in their contract with you, which would make the entire principal of the debt due immediately if you miss or are late on a payment. Also, some credit card company contracts provide for increased interest rates on credit cards under the same circumstances.

- Consider getting a small loan from a family member or friend. For obvious reasons, you should not be borrowing more money than you can afford to pay back, but this can be a interest and fee-free solution for you in a pinch. When and if you do this, remember that people expect you to honor your commitments in a timely manner. Don’t abuse someone else’s kindness by getting into a situation where you know you can’t repay an amount when you enter into the debt.

- Plan ahead. Start looking for solutions before you get into problems. Put off making a non-essential major purchase for several months if money is tight. Buying something expensive that you cannot afford will likely end with that item being repossessed and you being stuck with a valid debt on some amount a creditor couldn’t raise at a repossession sale. Consider looking into fixing things rather than buying new.

- The Navy/Marine Corps Relief Society makes interest-free loans to service members who can show a particular need. Their representatives can assist you with an application in an emergency, such as a death in the family, unexpected auto repairs or other calamities.

Military service members can contact the NLSO if you have any legal questions about payday loans.

5 comments:

Anonymous said...

I have poverty-level income and cannot get conventional credit, e.g. my credit union says I have insufficient income.

Sometimes payday loans are your only option.

Anonymous said...

I work for a short term/small loan lender... we're not a payday lender. We set up installments so the the customer isn't obligated to pay the ENTIRE amount their next pay date.

I agree with anonymous above... the advantage of our service isn't always clear for a few reasons:

1)The banking department actually FORCES us to put in an APR in our contract, even though we have a flat, daily charge per hundred, per day. It would be like adding an APR to a mug that you bought at a shop... it's just not the same. Typical PAYDAY style lenders charge 20/25 bucks for every $100 loaned for 2 weeks.

2) MOST responsible clients that take out a loan from us have bad credit & no other options. They are all WELL informed that if they don't pay the loans off QUICK, it is not to their advantage in the long run.

3) We work very hard to keep things moral. It is NOT to our advantage to give out a loan that someone cannot handle... clients that default on their loans are no good to us, & bringing people to court is a tedious & costly process that we would rather avoid.

4) The initial process of setting someone up with their first loan is around 45 minutes long, because we try VERY hard to educate people on what they're getting themselves into.

The above is where the problem exists... because many people are so fixated with "getting money," that when the underwriter/CSR is talking the words go in one ear & out the other. These clients are *irresponsible,* and are in their current financial situation (not to mention bad credit as well), because they lack the patience to actually LEARN HOW IT WORKS.

However.. it is definitely unfair to shut down small lenders, because it takes the service away from people who REALLY NEED IT, like first anonymous.

By the way, a lot of people use small loans as a BUFFER in their checking account to avoid falling in the negative to avoid certain bank fees. As expensive as the charge is, it still falls slightly cheaper than overdraft fees.

Anyway, I hope this helps

Anonymous said...

By the way... I have to add a little more to my comment above...

Our company would also not be able to stay in business if we charged a low credit rate for our loans... We just don't have enough customers.

It's a pipe dream for small businesses to try & compete with, for example, Bank of America... maybe in the future when we have millions of clients to feed us pennies at a time, we will think about lowering the charge. Unfortunately, we have employees, bills, & equipment to pay for.

While I'm at it, I would also like to say that people should be held accountable for their actions. If someone takes out a loan without thinking, without realizing the consequences of not doing the right thing, & without respect for a business that is genuinely trying to HELP their financial situation, they should have to face the consequences the same as if someone had defaulted on their credit... which people do ALL the time.

Finance Junkie said...

Nice to see that the payday lenders are trying to defend their biz model.

Tom Bro-KAW said...

Time to do some research. The Defense authorization act of 2007 prohibits payday loans and other similar products to active-duty members of the military.

This article appears to be a rehash of something written a few years ago.