Payday loans and the alternatives

In short

A friend of mine once borrowed 300 dollars on a Tuesday to fix his truck, and by the next payday he owed far more than he could pay. You have probably felt that squeeze, where a bill lands before the paycheck does. A payday loan is a small, short loan that comes due on your next payday, and the fee looks small until you see how fast it repeats. Before you sign anything, ask for the fee in dollars and the annual percentage rate, which is the yearly cost of the loan. Then call your lender, utility, or landlord and ask whether they offer a payment plan or a later due date. Check what a credit union near you charges for a small loan, and compare that cost to the payday loan.

The whole of it

What it is

I once watched a neighbor sit at her kitchen table with a stack of bills and a look that said she had done everything right. She had. Her car broke down in a month when money was already tight, and that is not a failing of character. A payday loan is meant for a moment like hers. You borrow a small sum, often a few hundred dollars, and you promise to pay it back on your next payday. Many lenders ask for a postdated check or access to your bank account so they can collect on the due date.

The appeal is plain. The loan is fast, the paperwork is light, and many lenders do not check your credit the way a bank does. When you are worried and the clock is ticking, that matters a great deal.

The trouble sits in the price. The fee is charged for a very short stretch of time, so when you turn it into a yearly rate it grows large. Fear of that number is not the point. Knowing it is, because you deserve to see the whole price before you agree to it.

How it works

A story helps here. Picture a man named Daniel who needs 400 dollars for a repair. The lender hands him the cash and charges a flat fee for each 100 dollars borrowed. Two weeks later the whole amount comes due, fee included, all at once.

Here is where the squeeze begins. If Daniel has the full sum on payday, he pays and walks away. But if paying it all leaves his rent short, he faces a choice. Many lenders let him roll the loan over, which means paying the fee again to push the due date out. He still owes the original 400 dollars. He has only bought more time, and he has paid for it.

You can see how that goes. One fee becomes two, then three. Each one is small, yet together they add up to real money. I would not call anyone foolish for falling into it. The design makes it easy to do.

The numbers, and where to find yours

Rules differ from place to place, so your own situation may look different from Daniel's. Some states cap the fee, and some limit how many times you can roll a loan over. A few do not allow payday loans at all.

Your first stop is the lender's own paperwork. Federal law requires lenders to disclose the finance charge and the annual percentage rate before you sign. That law is the Truth in Lending Act, and it exists so you can compare the cost of one loan against another. Ask to see those two figures in writing. If a lender hesitates, take that as useful information.

For the rules in your state, look to your state attorney general or your state banking regulator. The Consumer Financial Protection Bureau also publishes plain explanations of payday loans and how to file a complaint on its website, consumerfinance.gov. If you receive a federal benefit such as Social Security, remember that rules protect some of that money from certain collection actions, and the Bureau's site is a good place to read about it.

If you are an active duty service member, the Military Lending Act sets a cap on the cost of many consumer loans, and the limit is the current figure, which the official source publishes each year. Ask whether it covers your loan.

If you are thinking about a credit union loan, ask what it charges. Federal credit unions that offer a payday alternative loan are held to a ceiling on the interest rate, set by the National Credit Union Administration at the current figure, which the official source publishes each year. Ask your credit union whether it offers one and what the application fee is.

A worked example

Let me tell you about a woman named Maria. She earns 52,000 dollars a year, which is 2,000 dollars every two weeks before tax. A brake repair costs 400 dollars, and her next paycheck is two weeks away.

Maria finds a lender that charges 15 dollars for every 100 dollars borrowed. She borrows 400 dollars. The fee is 400 divided by 100, which is 4, and 4 times 15 dollars is 60 dollars. In two weeks she owes 400 plus 60, which is 460 dollars.

Now let us turn that fee into a yearly rate so she can compare it to other choices. The fee is 60 dollars on a 400 dollar loan, so the cost for the period is 60 divided by 400, which is 0.15, or 15 percent. A year holds 26 two week periods. So 0.15 times 26 equals 3.9, or 390 percent. That is the annual percentage rate, and it is not a typo.

Suppose Maria cannot cover the whole 460 dollars and rolls the loan over once. She pays the 60 dollar fee again and still owes 400. After two rounds she has paid 120 dollars in fees and owes the full 400 dollars.

Now suppose Maria instead calls her credit union and gets a small loan of 400 dollars at 28 percent annual interest, repaid over four months. Her interest works out to about 400 times 0.28 times 4 divided by 12, which is 400 times 0.28 times 0.3333. That comes to roughly 37 dollars across the four months, spread over small payments. The credit union rate is an example figure, so she should confirm the real one. Still, you can see the gap. Same repair, much lower cost.

Where it goes wrong

I have heard the same story from enough kind and careful people to know how it goes. The loan was supposed to be a bridge. It turned into a habit, and the habit turned into a trap.

The first danger is the rollover. Each new fee buys time but not progress. The second is the bank account. When a lender can pull money straight from your account, a failed payment can bring overdraft fees from your bank on top of the lender's own charge. That stacks cost on cost. The third is the calendar. A loan due in two weeks takes a big bite out of a single paycheck, and the next bill is already waiting.

Pride gets in the way too. People often feel ashamed to ask for help, so they skip the phone call that would have cost nothing. Please do not skip it. Asking is a sign of good sense.

Before you borrow, there are other doors you can knock on. Your employer may offer a paycheck advance, so you can ask. The company you owe may be willing to move your due date or set up a payment plan, and a call will tell you. A local nonprofit, a community action agency, or a religious group may keep a small fund for repairs and rent. The 211 line is a free help line that points you to local aid. A credit union is also worth a visit, since membership is often open to people in a certain area or job.

Questions to answer before you leave this page

Do you know the fee in dollars and the annual percentage rate for the loan you are thinking about, and have you seen them in writing? Could you pay the full amount on your next payday and still cover rent, food, and the other bills that come due? Have you called the company you owe and asked for a few more days or a payment plan? Have you checked with a credit union near you about a small loan, and asked what it charges? Does your employer, a local nonprofit, or the 211 line have help you have not tried yet? And if you borrow anyway, do you have a plan to repay it without needing to borrow again?