Every week, many thousands of Americans take out payday loans -- short-term loans that must be repaid from the next paycheck. These loans can drive consumers deeply into debt, said Ethan Ewing, president of free online consumer portal Bills.com, who provided tips to help people avoid the payday loan trap.
"When many people get into a financial bind, they go to a payday lending store and borrow a few hundred dollars," Ewing explained. "They plan to repay the loan in a week or two, when they have the money. But they pay a huge price. Payday loans can become a dangerous addiction that can cost hundreds or thousands of dollars a year."
Payday lending is big business in America. Nationwide, 22,000 payday advance stores loan more than $40 billion in short-term credit. The typical interest fee on a loan is $15 on a $100 advance, and most loans must be repaid within two weeks.
"While payday loans may make economic sense for some people in a few limited instances – such as using them to avoid a substantial late fee or bounced-check fee, or keeping electric service from being turned off – they can become dependencies that will cost you dearly," Ewing said.
Ewing suggested these techniques to avoid payday loans:
1. Understand the true cost of payday loans. Payday loans can have an annual interest rate of 400 percent. A recent study pointed out what that could mean, in real terms. Over three months, a $300 credit card loan at 16 percent interest would cost $15. A payday loan would cost $270. "It is not a good idea to rack up credit card charges that you cannot pay off entirely each month, but payday loans are far more costly than other forms of credit," Ewing explained.
2. Plan spending. Create a budget that accounts for all income and expenses. Plan funds for every category, and use self-discipline not to spend more. Be sure to devote some amount -- even if only a few dollars a week -- to saving for unexpected costs.
3. Create an emergency fund. Set aside money for use only in an emergency. Jump-start the fund by brown-bagging lunch, avoiding extras like coffee or CDs, holding a yard sale, or taking on a second job. Put the proceeds in a simple savings account. It is not a good idea to keep a lot of cash around the house, but if funds must be kept in cash, hide the money well -- even from yourself.
4. Avoid payday loan rollovers. The payday loan process can quickly get complicated. Many people "roll over" their loans, borrowing the loan again, rather than repaying it. The Federal Trade Commission has pointed out that the cost of three rollovers on a $100 loan could total $60. Over time, some people wind up giving more than half their incomes to payday lenders.
5. Check into overdraft protection. Many banks offer overdraft protection service that, for a small fee, allows a check or debit to clear even without enough funds in the account. It is not ideal, but the cost is much lower than a payday loan.
6. Borrow from a friend or relative. "If you just need a few dollars to tide you over, ask for an IOU. However, an unpaid loan can destroy relationships, so don't use this option unless you know you can pay it back -- and borrow only on a rare occasion," Ewing cautioned. Put the agreement in writing, including moderate interest you will pay or a favor you will do in return.
7. Talk to the creditor. If a medical bill is the problem, for instance, ask the doctor about making payment arrangements. Most medical providers will work with patients to pay the bill in a way they can afford.
8. Get help. If bills typically are more than you can pay, look into all the options. If necessary, check with a reputable debt settlement firm to help find a way to get debt under control.
"If you find yourself in a tight financial spot, don't make the problem even more stressful with burdensome interest rates and ongoing debt," Ewing said. "With careful planning, you can avoid the payday lender -- and find financial freedom."
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