Payday loans are billed as a quick way for borrowers to receive small loans, with no collateral or credit requirements.
But the cost of the loans, which proponents say are supposed to be for emergency use, is extremely high. In California, each $100 borrowed costs up to $15; thus the fee on the maximum allowed $300 payday loan would amount to as much as $45. The annual percentage rate on that deal comes out to a whopping 460%.
But do these borrowers, who might turn to payday loans to get money for recurring expenses, such as for groceries or housing, have better options?
They may. The answer depends on why the money was needed. Sometimes the best option isn’t a loan at all.
Paul Leonard, California director of the Center for Responsible Lending, says payday loans are frequently used to pay regular monthly expenses. That, however, is what the country’s social safety net is for. There are federal food stamps and some housing aid available. Alternatively, there are charities that might be able to help.
The United Way operates a poverty resource center that can help cash-strapped Americans find emergency food, shelter and cash to pay utility bills. Those with too little income to fill prescriptions for chronic ailments can also sometimes receive prescription medication free or for a small fee.
In many parts of the state, including Los Angeles County, people in need can dial 211 — a free round-the-clock help line — to get information about a variety of local aid programs. (You dial it just as you would 411 for information or 911 for emergencies.)
Because payday loans are available only to people with jobs, those who qualify for this type of loan are also likely to qualify for the earned income tax credit, a federal tax break for the working poor. You don’t have to wait until you file an annual return to receive it either.
Employers are required to allow qualifying workers to claim the credit in equal installments through their monthly paychecks. The maximum earned income tax credit is adjusted each year, but in 2010 it amounted to $5,666 for someone with three or more children. That could boost this family’s monthly income by $472, potentially eliminating the need for a short-term loan.
What about an emergency car repair? Leonard says that roughly one-third of those who get payday loans have credit cards that they can use to pay these unexpected bills. Even the highest-cost credit card is far less expensive than a payday loan. Minimum payments on a $300 credit card loan are also likely to amount to less than the upfront fees on a payday loan, making this a better long-term way to borrow.
None of those options work? Pawn shops also offer loans at a far lower cost than payday lenders. Zaks Pawn Shop in Los Angeles, for example, said it would provide a loan for up to 100% of the value of gold and 20% to 30% of the value of electronics.
The fee? It’s $18.50 for a $100 loan. But that gets you four months of credit. For four months of credit on a payday loan, you’d have to renew it eight times, paying a total of $120 for a $100 loan.
The alternatives to payday loans are often less likely to result in a never-ending financial quagmire for a borrower, Leonard said.
“The first rule is that when you’re in a hole, stop digging,” Leonard said. “The idea of taking on this extremely expensive, extremely sticky thing called a payday loan is only going to make your financial situation worse. There are better solutions.”