Automated payment systems at high risk to overdraw your account.
If you think high interest charges are the worst thing you’ll face if you take out a payday loan, a new study by the Consumer Financial Protection Bureau may surprise you.
“High interest rates are just the beginning. Payday loans can also cost borrowers hefty overdraft fees when lenders try to collect.”
These conclusions were reached after an 18-month study, which followed the account repayment process of almost 20,000 payday loans in the U.S. During that study:
- Roughly half of payday borrowers missed at least one repayment during the study
- The overdraft fees triggered averaged $185
Generally overdraft fees don’t get that high. In fact, while bank overdraft policies vary from a $10 at some institutions to up to $90 at others, the average overdraft is only $34. However, since payday lenders usually have direct access to a bank account because of automated payment transfer systems, that means they can submit payment requests again and again.
“For one bank account, the study found 11 payment requests in a single day.”
So even though there were not funds in the account the first time, the lender continued making payment requests repeatedly, incurring an overdraft for every time the payment attempted to process. CFPB Director Richard Cordray pointed out that this repetitious payment request abuses a system intended to make repayment more convenient.
“Of course lenders that are owed money are entitled to be paid back,” Cordray said. “But we do not want lenders to abuse their preferential access to consumers’ accounts.
The study also confirms that the average interest rate applied to a payday loan is 390%. So while payday loans aren’t all bad, the deck is stacked heavily against borrowers who are trying to use payday loans to get by.
Are payday loans ever a good idea?
In theory, payday loans are not the root of all financial evil. A short-term installment loan that you can get quickly without a credit check can be useful in some circumstances, and as long as you pay back what you borrowed quickly you can use payday loans successfully without facing the issues that payday loans are notorious for causing.
The problems with payday loans really occur if the amount borrowed is not repaid immediately in-full. If you don’t pay back everything you borrowed within the first billing cycle, interest and finance charges are assessed and the payments can quickly balloon, making it almost impossible to get ahead and eliminate the debt.
Additionally, as this article describes, most payday lenders have direct access to the bank account you provide. This allows them to put the money into your account the same day or the next day, but it also allows them to take payments automatically from your account. If you get behind and don’t have funds in your account to meet your payment schedule, this is where you can face the hefty overdraft fees described above.
“Unless you are certain that you will have the money you need to repay the loan amount in-full with your next paycheck, be careful!” warns Gary Herman, President of Consolidated Credit. “Using payday loans to cover daily expenses in your budget because you don’t have enough income is just creating a high-risk situation you don’t need.”
Instead, Herman recommends that when money starts to get tight, people should explore options for real debt relief instead of using quick-fix solutions to make ends meet for another month.
“Hoping for better days ahead and using payday loans in the interim rarely work out the way people hope it will,” Herman explains. “You’re usually better off to bite the bullet and get into a debt relief program so you can achieve stability and really move forward.”