Many Americans are increasingly turning to high interest, short term loans to try to make ends meet, but a brief overview of payday lending's problematic setup shows that it's often a false solution to a false problem.
Payday lenders claim to be a convenient source of credit for low- to moderate-income families in a budget crisis. Yet a revealing study from Pew Research shows that contrary to common assumptions, borrowers typically use payday loans to pay for day-to-day expenses, not emergencies.
Payday loan centers tend to concentrate in minority neighborhoods underserved by mainstream banks, capitalizing on economic vulnerabilities brought on by decades of discriminatory legislation, financial deregulation and a decline in savings. Lower-income workers use payday loans to try to reconcile their stagnant wages with the rising cost of living, only to find that they've added another bill to their budget. With little or no savings, borrowers struggle to pay off the loan balance on time amid sky-high predatory interest rates, leading them into what consumer advocates call the debt trap.
Payday lenders regularly mislead their customers by advertising their fees as a dollar amount rather than an APR, or annual percentage rate. Paying a $50 fee for a loan of $500 over a period of two weeks may not seem that bad at first glance, but that fee overlooks the fact that borrowers take an average of five to eight months to pay back their loans. If you calculate the loan's APR, or what that loan would cost over the course of a year, the true interest rate balloons to a level far beyond that of most credit cards and bank loans -- a whopping 260 percent. Doing the math is essential to avoid ruinous setups offered by lenders such as Western Sky, which offers a $5,075 loan that can lead to an appalling $40,872 in repayment.
A payday loan may seem like a short-term fix, but it's ultimately just another expense. In today's economy there are no easy answers for low- to moderate-income Americans struggling to pay the bills, but what will clearly never work is adding another high-cost loan. However difficult, the only path forward is to reconcile your cost of living with your income by evaluating areas where you can cut costs and make the most of your income. This means scaling back on extras and creating a long-term, sustainable budget that enables you to invest in your future.
When faced with a real emergency, don't discount relying on your friends and family. Many borrowers go to payday lenders to avoid borrowing from family and friends, only to end up asking for assistance later to get out of the debt trap. You may also investigate viable loan options at mainstream banks and financial institutions by assessing their APR and fees. And as you continue to trim your day-to-day costs to fit your income, your goal should be to build up a savings cushions for emergencies -- that's money you can loan to yourself, interest free.
Dedrick Muhammad is the senior director of the NAACP Economic Programs. To learn more about preventing foreclosure and personal finance, check out the NAACP Financial Freedom Center Facebook Page or on Twitter @naacpecon.