Payday loans are just as risky as you think, CFPB reports

New study reveals the payday treadmill isn’t an exaggeration – it’s real and it’s causing serious problems for consumers.

Unless you just haven’t been paying attention for the past few years, you’ve probably heard somewhere that payday loans are bad for your finances. Terms like a “never-ending debt cycle,” and “payday treadmill,” have been coined to describe how once you take out that first payday loan, it can be easy to get stuck on a constant downward spiral of borrowing.

Still, with so much negative press, it’s almost easy to think the stories might be exaggerating or that people are just scare mongering. Yet a new report from the Consumer Financial Protection Bureau (CFPB) shows that the statements are blowing the issue out of proportion. In fact, the findings confirm that payday loans seem to do more harm than good in most cases where they’re used.

When facts confirm what you already know

Think we’re exaggerating? Think again. The following statistics shed some light on how effective short-term loans are as a financial tool:

  • 3 out of 5 payday loans – the fee expenses exceed the amount borrowed
  • 4 out of 5 payday loans – the loans get rolled over or renewed
  • 4 out of 5 rolled over / renewed loans – the new loan takes out more than the first
  • 1 out of 5 payday loans – the new loans cost more than the amount borrowed

So payday loans are like potato chips with a ton of trans fat – you can’t have just one and the whole bag is probably going to do serious damage to your health.

Why is it so easy to get into trouble?

Payday loans are a short-term lending system. When used correctly, you’re supposed to borrow a finite amount of money for a short period of time. So if you water heater breaks on Monday and you don’t get paid until Friday, you can cover the cost of the repairs without waiting for your paycheck to post.

However, more often than note (about 80 percent of the time according to the survey), these loans are being used for something else – namely, covering budget shortfalls. People try to stay afloat taking out one payday loan after another.

The lenders are more than happy to roll the loans over, because that means more fees and interest for them. So instead of rejecting your application, they send you back to double down on shaky financial ground. By the time they cut you off, it’s already too late.

What is the solution?

CFPB head Richard Cordray explains, “As we look ahead to out next steps… we can formulate new rules to bring needed reforms to this market.” Even Cordray admits that these loans can be useful, so the industry can’t be eliminated completely. However, “We intend to make sure that consumers who can afford to take out small-dollar loans can get the credit they need without jeopardizing or undermining their financial futures.”

In the meantime while the CFPB gets new regulations in place, it’s up to consumers to make sure they don’t wind up on the slippery payday slope. You should only take out a payday loan if you have an actual short-term need AND you have a plan to pay off the loan immediately.

Otherwise, you should stay away from short-term lending. If you’re falling behind on your bills and can’t keep up with your debt payments, payday loans are not a solution! Instead, you should consolidate your debt to lower your payments so you can get some relief for your budget. In the end, a long-term solution will get you ahead faster than quick fixes like payday loans.