The old saying that it takes money to make money seems to have a corollary, especially within the payday loan industry. There, it takes debt to make more debt. The payday loan business claims it serves an underserved demographic, that of low-income consumers who may need a loan (if they were a large corporation, it might be termed a "bridge loan") to help them out until payday.
According to the marketing copy, the consumer uses it to cover their rent, groceries or heating bill until they receive their next paycheck. Then they pay the loan off, and everyone is happy. Except when they don't, and then they often need a second personal loan to pay off the first one.
These loans have a simple approval process. But that convenience comes with a price. A very high price. A recent study by a think tank found that a $300 loan typically costs the borrowers $800. Fees are so extreme, up to 574 percent, that they can trap borrowers on a treadmill of debt.
These lenders tend focus on low-income areas of a state and areas there are few banks. What is most surprising is that almost $50 billion in loans are made by this industry.
The fees they charge operate on a slight of hand, because the loans often only last a few weeks, a 15 percent fee may seem nominal but it works out to annualized rate of 460 percent.
The report found that in California, borrowers who had more than six loans per year generate over half the revenue for the industry in the state.
If possible, avoid payday loan entirely. It is better to scrimp and save for a few months than to risk becoming entangled in the sometimes endless cycle of a payday loan.
Source: Milken Institute, "Where Banks Are Few, Payday Lenders Thrive," James R. Barth, Priscilla Hamilton, and Donald Markwardt, October, 2013