Try to imagine a mechanism that doesn't look at a consumer's credit history, gender, sex, religion, or income, awards them with money whenever they ask, and potentially serves as an individual's only means of acquiring emergency money. This non-discriminatory monetary mechanism comes with a catch though: it has an exorbitantly high interest rate and is built in such a way that some say they inherently trap their users in a never-ending downward spiral of financial hardship and debt. No, this isn't a hypothetical concept brought about for a philosophy class's ethics discussion. What we're talking about is a payday loan.
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The Anatomy of a Payday Loan
Payday loans are a type of financing that requires no more than a post-dated check in return for cold, hard cash. They're the preferred method of acquiring cash advances on one's paycheck, particularly for those with bad credit ratings or no credit scores at all, since collateral and history are foreign and useless concepts to payday lenders.
But the equal and opposite reaction to such light lending standards comes in the form of high-often called excessive-fees and very short terms. Most of these loans are granted at a rate of roughly a dollar a day and are expected to be paid off within a two-week time period. When such a fee is stretched out and measured by the same standard as other types of loans, the results are astounding.
Annual percentage rate (APR) is the Rosetta Stone of the lending world, and grants consumers a quick look at how much a particular loan costs when compared to other offers. The APR tells consumers how much a loan's interest would cost if the loan were held for one full year. Home loans, for instance, often come with an APR of below 10 percent. Auto loans can usually be found with APRs of between 5 and 12 percent. Payday loans, however, carry a 390 percent APR-and that's on the low-end of the scale. Some of these quick cash advance loans have been reported to breach 1,000 percent.
Isn't that Usury?
The word that pops into most peoples' minds upon hearing this is "usury." Usury, a word that has been wielded and used by consumer advocates since biblical times, refers to charging an excessive or unreasonable amount of interest on loans. While some states do prohibit or restrict payday loans based on the argument of usury, many allow this practice to continue by exempting it from usury laws. But why would any state subject their citizens to such high interest rates?
One void that payday loans fill is the demand for money regardless of financial history. The fact remains that most people need to borrow money at some point in their lives, but not everybody has pristine-or even moderately acceptable-credit scores. Historically, this void has been filled by private, often illegal, lenders. These lenders, usually referred to as loan sharks, rely not on extra fees for late or missed payments, but rather have been reported to enforce payment through the use of intimidation, injury, or even murder.
Many states realize that payday lending provides society with a service that is actually a necessity. For families with low-income or little savings, payday loans can deliver money for unexpected bills and expenses when paychecks are still days away. For others, these cash advances can grant financial relief when paychecks come sporadically, infrequently, or only once a month.
Whatever the reason, this type of borrowing is demanded, and thus many states allow its supply. But despite the necessity for short-term cash, the issue of trapping those who are already enduring financial hardship in an endless cycle of payday loan rollovers needs to be addressed. Then both consumers and lenders will be able to partake in a healthy business relationship.
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