When bills, car payments, and other nagging expenses pile up and the checking account is running low, it’s tempting to look for an easy way out, some quick green to lighten the financial burden a bit.

A payday loan is a common form of fast money that the cash-strapped often turn to. With no credit check required and money in-hand quickly, payday loans seem like an easy solution to dealing with mounting expenses.

Sure enough, 12 million Americans a year use payday loans to fill the gaps in cash flow, but are they worth the high interest?

We’ve compiled some useful information and statistics to better educate you on the ins-and-outs of payday loans — and why they should be avoided if possible.

What is a payday loan?

  • Unlike loans used to cover large expenses like a mortgage loan or a student loans, a payday loan is a small loan based on the borrower’s pay–a loan amount usually around $500 and rarely over $1000–intended to tide the borrower over during financial emergencies until they can pay the loan back along with interest within 1-2 weeks using their next paycheck.
  • The fee attached to an average payday loan is $55 dollars to be paid back within two weeks, and the typical loan requires a lump-sum repayment of $430, i.e, paying in installments is not permitted with this type of loan.
  • Despite the fact that payday loans are advertised as being helpful for unexpected circumstances or emergencies, research shows that 70% of borrowers use them for regular, recurring expenses like rent, utilities, and car payments.
  • Taking out a payday loan typically requires employment and income verification, as well as valid identification, although a credit check is not necessary. Attempting to search for the best deal on a payday loan is mostly futile, as the market is not price competitive, with lenders generally charging the maximum amount possible under state law.
  • Laws vary from state-to-state on the maximum fee allowed for a payday loan, although $15 dollars for every $100 borrowed is a common fee. This calculates into a whopping 400% annual percentage rate (APR), which dwarfs the APR on most types of loans and credit. For example, credit cards typically have an APR of 12%-30%. While some say that APR is not a good way of assessing a short-term loan like a payday loan, not everyone is able to pay back the loan within the customary two-week period, as we’ll see later. That interest can add up fast.

Who takes out payday loans… and why

  • According to a Pew Charitable Trusts survey, 5.5% of adults in the United States have taken out a payday loan in the past 5 years, with the average borrower earning around $30,000 per year.
  • While people from all demographics use payday loans, most borrowing is done by younger folks without a college degree. The survey revealed that a majority of borrowers are women and white, however other factors can be a better indicator of a person’s likelihood of using payday loans.
  • For example, those that are separated or divorced (rather than single, or married) have 103% of using a payday loan in the past, while African Americans have a 105% higher likelihood of using them. Furthermore, those that rent their homes are more likely to use payday loans compared to those that own their homes.
  • In essence, payday loan users are often people in desperate situations with little recourse. In fact, 58% experience difficulty meeting their basic monthly expenses.

As stated before, payday loans are commonly advertised as the last resort in the case of emergency, but borrowers more often use them to pay rent, utilities, car payments, or to put food on the table. What’s worse is that once people begin to use payday loans, they become trapped in a cycle of borrowing that it becomes difficult to emerge from.

The risks of payday loans

Payday loans are meant to be a one-time solution in an emergency situation, and if no other options are on the table, it might serve its purpose and provide the borrower relief at a manageable cost. However, in reality, it doesn’t work out that way.

  • Alarmingly, 80% of payday loans are either rolled over into another pay period or followed by another payday loan within two weeks. The average lump-sum payment swallows up 36% of the already cash-strapped average borrower’s total paycheck. Due to the high costs of the loans relative to a borrower’s income, the borrower gets locked up in a desperate cycle of debt, taking out more payday loans just to pay back earlier loans.
  • A report by the Consumer Financial Protection Bureau (CFPB) uncovered that 15% of new payday loans begin a loan sequence 10 loans long, or longer, and that half of all outstanding payday loans are part of a sequence at least 10 loans long.
  • The data on monthly payday loan borrowers are revealing: they are much more likely to stay in debt for 11 months or longer compared to the rest of the populace. They are also more likely to be recipients of government benefits.
  • In light of the economic status of the most common payday loan borrowers, it may be that they have few other options available, but getting caught in a loan sequence actually does much more harm in the long run, with interest consuming a large percentage of the borrower’s income. Consider this: those taking out 11 or more loans are responsible for 75% of payday loans. The payday lending industry is one of the more predatory financial services by nature.

Where are people getting payday loans?

In the United States, payday loans are available in 36 states. While such loans aren’t necessarily banned outright in the states they aren’t available, many states either rate cap APR (remember: the APR of payday loans is around 400%) or have other laws rendering the payday lending industry unprofitable.

The following states prohibit payday loans:

  • Arkansas
  • Arizona
  • Connecticut
  • Georgia
  • Maryland
  • Massachusetts
  • New Jersey
  • Pennsylvania
  • North Carolina
  • Vermont
  • West Virginia

An interesting case is how Colorado has recently dealt with payday loans by replacing the standard two-week payday loan with new rules and a six-month installment model with far lower interest rates. In response to the new regulations, half of payday loan stores closed, although the ones that remained open are now twice as busy.

Nowadays in Colorado, payday loan borrowers pay just 4% of their next paycheck in interest, rather than a percentage in the high-thirties as is typical of the standard payday loan arrangement in other states. Furthermore, 75% of borrowers pay back their loans early, saving more than $40 million dollars annually.

The revamped payday loan market model in Colorado is a promising development and should point the way for how other states regulate the payday loan market in the future.

Payday loan alternatives

While a bad credit score may be a limiting factor for those seeking an alternative to using high-interest payday loans to cover expenses, it never hurts to see what one qualifies for.

A personal line of credit, which is a loan that works like a credit card in that the borrower is approved for a certain amount, yet only pays interest on the amount actually used, is a favorable alternative to payday loans. Plenty of banks, credit unions, and other financial institutions offer personal lines of credit, and the interest rates are much lower than payday loans, so it’s definitely something to check out if unexpected expenses come your way.

Credit card cash advances are another option. Though they carry high-interest rates, borrowers aren’t required to pay back the borrowed sum in a short two-week time frame as with payday loans, so they are a preferable alternative if one can utilize them.

Summary

  • While payday loans might seem like a quick fix when one is in need of some emergency cash, we’ve seen the heavy back-end burden can be overwhelming for most payday borrowers.
  • The numbers don’t lie: users of payday lending often get caught in loan borrowing sequences spanning ten loans or more.
  • Unless one has no other recourse, potential borrowers are strongly advised to seek alternatives to taking out payday loans.
  • Few types of loans have more unfavorable terms than these types of loans, which is why they are so easy to take out.
  • Payday lenders take in 9 billion in loan fees each year, i.e., borrowers’ hard-earned money.