The data both returned and implied some interesting inconsistencies about the marketing of payday loans, and the truth about its consumers. While industry advocates claim that these “short-term” loans are meant to be used in cases of emergency only, the research has shown that an average borrower takes out eight loans, and is in debt for an average of five months. In fact, a customer only becomes profitable to the lender if it takes out multiple loans. So while these loans are purportedly meant to be used for emergencies, it comes as less of a surprise to find out that 69% of borrowers use their first payday loan for a recurring expense (rent, utilities, etc.), with subsequent loans often taken out to cover the first. Instead of seeking other means to cover these regular expenses--81% of respondents claiming that they would cut back on expenses if payday loans were unavailable--these borrowers get trapped in a cycle of debt.
Usage of payday loans is shown to have a correlation with some predictive factors, the strongest of which being: renting (as opposed to owning) housing; earning less than $40,000 a year; lacking a 4-year degree; being separated or divorced; and having a minority racial/ethnic background. Most of our clients fit at least one of these criteria, and are thus more vulnerable to payday loan usage.
Another factor that leads to borrowing is a lack of understanding around opaque interest rates. Some of Pew’s respondents verified a confusion between the fees accompanying payday loans with the APR that would normally accumulate on credit-card debt. If a particular lender is charging $15 for every $100 borrowed, many customers will see this as a 15% interest rate, and choose this option over a credit card that charges an interest rate of 23.99 APR. However, the study showed that the typical payday loan has an APR of 391%. Texas, being one of the most permissive states in payday loan regulation, allows for incredibly high fees on each loan. For the same loan that would cost $55 in fees in Florida, a Texan would spend $100.
Our Small Business Coaching Coordinator Lance McNeill has written a brief narrative of the most susceptible borrower, to show how these numbers play out in reality:
Let’s take a look at the scenario of one lady; 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 than other races/ethnicities), she’s 28 years old, divorced, making under $25,000 a year, she never graduated college, and she 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 on the corner, 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 fast-quick-easy with $375 for her car payment – whew, just in time!
Two weeks rolls by before she knows it and it’s time to repay her loan. Betty owes the $375 plus $56.25 in interest (In 28 states, including Texas, this is perfectly legal). The bind Betty has put herself into isn’t difficult to deduce. Because of the payday loan, her car payment basically went from $375 to $431.25 in the course of a month. Now, she’s coming up short for her rent, which is due in a couple of days, so she has to renew that loan – and the vicious cycle begins. As I mentioned previously, the average borrower rides this cycle 8 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 a year! For anyone curious, that’s 391% APR and yes, this is entirely legal in 28 states, including Texas.
Many of our clients fit the profile of this repeat borrower, or fall into place with other target demographics of the most susceptible consumers. It is important for our coaches to know the facts about payday loans in order to stem their use among clients, and help them to see the alternative ways to meeting bills. However, it’s often too late in terms of preventative measures. In an attempt to alleviate the burden of overwhelming interest rates, we offer our Financial Coaching clients a chance to reduce that 391% rate to a flat 8% by taking out our Fresh Start Loan. This loan will pay off the clients’ current lender in a lump-sum, transferring the debt, with all payments due to Foundation Communities. We ask that our coaches familiarize themselves with the criteria that the client must meet in order to be considered for the Fresh Start Loan, and to be aware of this as a possible solution to some clients’ situations.
We encourage you to read the entire Pew study for an in-depth view of the study’s results. This month, our Featured Resource on the volunteer resource page is a quiz meant to test your knowledge of Payday Lending.
