Low Dollar, High Risk: How Payday Loans Trap 12 Million Americans in an Endless Cycle of Debt

Amanda Spurgeon

I recently posted a question on Facebook: have any of my friends ever taken out a payday loan?

This quick survey really only taught me one thing. A lot of people have very strong opinions about payday loans, whether they’ve ever used them or not. This is probably due in large part to some anecdotal coverage of the payday loan industry in the news recently (see: this segment from Last Week Tonight with John Oliver).

I may not need to tell you this, but the overwhelming opinion of payday loans is intensely negative. Run a quick poll on Facebook for yourself or enter a query on Reddit’s r/personalfinance and you’ll see what I’m talking about. Average Joe seems to clearly understand that payday loans are bad news.

Why, then, are twelve million Americans getting wrapped up in this get poor quick scheme every year? Not because they don’t understand the potential dangers of payday lending. Rising inflation and stagnant wages have left the average American few places to turn when they can no longer make ends meet and when faced with a decision like getting evicted or spending half the year paying off a $375 loan, the risk is worth it.

WHAT’S THE DEAL WITH PAYDAY LOANS AND LENDERS ANYWAY?

You probably see these shops pretty frequently without thinking much of them. According to Google Maps, there are at least 10 of these establishments within a fifteen-minute drive from my house. Prior to starting this research, I was only aware of one on my drive to work, but once you start looking for them, they’re everywhere.

The products they sell are generally billed as twoweek, fixed-fee loans with a lump-sum repayment plan. The requirements vary from lender to lender, but generally all you need to get approved is an active checking account and proof of income. A credit check is seldom required, making them a goto for those with poor or no credit.

On the surface, they seem relatively harmless. Borrowers agree to pay a one-time fee, usually around $10 - $15 per $100 borrowed, and pay the loan back within two weeks. Because these loans average only $375, it doesn’t seem unreasonable to expect payment that quickly, right?

And yet, according to research from Pew, the average borrower has to renew a $375 loan eight times before they’re able to pay off the principle and end up paying $520 in fees all for the original loan.

That’s because at the end of two weeks, their financial situation hasn’t improved. They can’t afford to pay back the whole $375, but they can afford to pay another $50 fee to renew the loan.

So now a product marketed as a short-term solution for an unexpected or one-time expense becomes a five-month ordeal. Where’s the disconnect? To find out, we need to understand who takes out these loans in the first place

WHO TAKES OUT PAYDAY LOANS AND WHY?

According to the Pew Charitable Trust’s small loan research, the people who frequently seek out payday loans are surprisingly diverse. Though most payday loan borrowers are white women between 25 -44, there are five main groups of people likely to have used a payday loan:

• Those who don’t have a four-year college degree

• Those who are separated or divorced

• Those who earn less than $40,000 a year

• African-Americans

• Home renters

Based on what we know about short-term lending, one might assume that income is the main factor in determining what makes these groups more likely to seek a payday loan, but according to Pew Charitable Trusts, income is just a small piece of the puzzle:

“It is notable that, while lower income is associated with a higher likelihood of payday loan usage, other factors can be more predictive of payday borrowing than income. For example, low-income homeowners are less prone to usage than higher-income renters: 8 percent of renters earning $40,000 to $100,000 have used payday loans, compared with 6 percent of homeowners earning $15,000 up to $40,000.”

Payday loans may be marketed as a solution for unexpected expenses, like car repairs or medical bills that come up when you’re between paychecks, but most borrowers use these loans to pay routine living expenses. In a recent survey, 69% of respondents said they used these small dollar loans to cover known recurring expenses, like their rent or mortgage, credit card bills, utilities or to purchase necessities like food or hygiene products.

Knowing how these loans are frequently used, it’s easy to jump to the conclusion that financial education, on budgeting, reducing expenses or even just the dangers of these predatory loans, can help prevent more borrowers from falling into the trap.

But is education the issue? My gut says no, and social media is one way to validate it.

Gathering information for this article I spent a short amount of time skimming posts on Reddit. What are people in the online forum saying about payday loans?

Five out of the first 15 posts start something like this, “So I knew it was a bad idea before this ever started, but I was in a bind. . .” or, “I’ve heard a lot of bad news about payday loans, but I need a couple hundred dollars. . .” or, my personal favorite, “To clarify, I know payday loans are terrible. I’m not stupid. . .”

Now I’m not saying a handful of posts online are indicative of the knowledge held by all payday loan borrowers, but I do think it shows that to some extent, borrowers know that they’re setting themselves up for trouble.

If ignorance about the inherent dangers isn’t the problem, could it be a lack of overall financial knowledge? Would teaching frequent borrowers how to set a budget, ways to cut back on expenses etc. help prevent them from seeking these predatory payouts to help make ends meet?

WHERE EDUCATION FAILS TO SOLVE THE PROBLEM

To some extent, financial education may help borrowers who seek payday loans to repair the financial situation that drove them to borrow over time, but does nothing to solve the short-term issue of needing cash now. Debt elimination plans can take months or even years, depending on the circumstances. Reducing expenses is a good guideline for everyone, but what if you’re already only spending the bare minimum to survive? Should you give up a home in a safe neighborhood to save a few hundred dollars a month and live in fear somewhere dangerous?

With the price of rent on the rise in most major markets, the high cost of divorce and limited high paying job options outside the labor sector for individuals without four-year degrees, one may draw the conclusion that financial instability and outside economic factors, rather than low income and lack of financial education, are the real issues leading borrowers to seek assistance with their everyday expenses.

Making such a claim may seem crazy given the strength of our current economy. On the surface, things are looking pretty good for American workers: 1.5 million new private-sector jobs have been created since the beginning of the year and unemployment is the lowest it’s been in decades at only 3.9%. How could I possibly blame payday loan usage on “outside economic factors?”

Because despite a growing jobs market, wages are stagnant for everyone but the highest earners. According the Bureau for Labor Statistics, your paycheck may actually be worth less now than it was a year ago. From July 2017 – July 2018, prices rose 2.9% while wages grew only 2.6% during the same period, meaning many Americans will likely need to work more and for longer hours to maintain the standard of living they enjoyed a year ago.

Speaking of that standard of living, it may not even be that great to begin with. Let’s put it in terms of dollars and cents. According to the Labor Department, the average “real” wage (the wage after adjusting for inflation), is $10.76 as of August 2018, down from $10.78 at the same time last year. A recent report from Pew Research Center says the real wage now has about the same buying power as it did 40 years ago.

“In fact, in real terms average hourly earnings peaked more than 45 years ago,” writes Pew’s Drew Desilver. “The $4.03-an-hour rate recorded in January 1973 had the same purchasing power that $23.68 would today.”

So what does all that actually mean? While earning more might make the average person feel like they’re on track to improve their finances it doesn’t actually mean they’re any better off or have any more income than they did in previous years when they earned a lower wage. Until wage growth exceeds that of inflation, this isn’t likely to change.

With the dollar taking us shorter and shorter distances every year, it’s not surprising that 12 million Americans find themselves in need of shortterm funding to make ends meet. Yes, financial planning is important but it can’t increase the value of wages or solve problems inherent with the lumpsum payment system associated with these small dollar, short-term loans.

Though legislators are working to reform the payday loan industry and curb predatory lending, their attempts only address the issue from the side of regulation and do nothing to address the economic factors that lead Americans to seek these small, expensive loans in the first place. Until we can fix the consumer side of the issue, I expect we’ll see continued usage of payday loans despite the known, inherent dangers.