The Online Payday Loan: A Trap on Your Phone

I will never forget the day I learned about payday loans. I was in my pre-requisites for my nursing license taking a course on socioeconomic status and its impacts on healthcare. Our professor put on a documentary that described the differences between neighborhoods of various income brackets. Areas with higher poverty markers were more likely to experience food deserts, or the lack of access to fresh healthy food. What these neighborhoods lacked in grocery options, they made up for with predatory lending offices. I had no idea just how many people fell into the sticky trap of these loans until I became a financial coach almost a decade later.

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What is a payday installment loan? 

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You may have heard this term, but let's review the characteristics of these loans. Payday loans are typically smaller loans with high interest rates. The annual percentage rate (APR) can range from 200-500% and sometimes more (Loftsgordon & O'Neill). Your next payday is usually the due date, hence the name. Lenders do not factor in your ability to repay the loan and do not require credit checks to apply. To get this "quick money", you just prove your identity and give an account number. The benefits of instant funding are quickly outweighed by the cost.

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Short term loans may look appealing if you have financial needs that outweigh your bank account balance. The U.S. military classifies payday loans as predatory loans and prohibits lenders from charging servicemembers more than 36% APR (Loftsgordon & O'Neill). That alone should be a big red flag. If the government knows these loans are dangerous, why doesn't the general population?

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Rarely does one cash advance fix deeper money management issues. Lenders bank on the borrower struggling to repay the initial loan and continue to profit when they need more loans. The Consumer Financial Protection Bureau (CFPB) estimates that almost 70% of payday loan borrowers take on a second loan within a month (Loftsgordon & O'Neill). It becomes easy to get trapped in a vicious cycle of debt. To protect yourself from these lenders you just need to avoid bad parts of town, right?

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The trap of online payday loans

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Before the internet, these storefronts existed in impoverished neighborhoods to take advantage of the population nearby. Today, anyone over the age of 18 with a social security number and a phone can be lured into these traps. A few searches of phone apps for "cash", "loan" and "money" reveal dozens of apps with offers to borrow money instantly. After reading this blog, check out your phone's app store and see for yourself. The graphics are fun and enticing for the younger users. More than ever, young borrowers are able to access high interest, short term loans right from their fingertips.

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These are not your friends

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Have you heard of Dave, Brigit, Albert, Gerald, Cleo or Klover? Did you know those are all apps that make it easy to borrow money at high interest rates? Each of them has a fun logo. Dave is a cute bear with glasses, what could go wrong? I have seen many clients fall prey to these apps thinking that they were no different than borrowing from a reputable bank. When easy money is offered, there is always a catch.

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Real client examples

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Before I became a financial coach, I assumed that everyone was aware of their borrowing terms and would make educated decisions. I have since learned that financial literacy goes well beyond awareness. Companies intentionally make it hard to decipher exactly how much a loan will cost you. They are required by law to provide that information, but it is usually buried in paperwork and surrounded by complicated financial jargon. Let me introduce you to some real clients with their names changed for privacy.

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Client Sarah

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Sarah came to me in a mountain of debt. She had no idea how much her loans were costing her, and seemed to need more each month. She had seven short term loans with interest rates ranging from 121% to 775% (and nope, those aren't typos). We spent time reviewing her lending documents carefully. They were often upwards of 40 pages each. Sarah was shocked when I demonstrated that her $350 loan at 775% interest would cost her a total of $1,739 when paid over the term of 7 months. You don't need a calculator to see how expensive that is. A whopping $1,389 of that total would have been money in that cute bear's pocket.

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Client Jack

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Jack joined my coaching program when he realized his spending had gotten out of control. He did not have money set aside to plan for future expenses, let alone unexpected situations. He found some short term loans to cover these rainy days but did not realize the true cost. He figured a friendly-looking app wouldn't be that bad, and easily applied within minutes. One of his loans was for $350 over 3 months with a 682% interest rate. If he took the entire term to repay the loan, it would have cost him $586 in interest charges for a total cost of $936.62. Ouch.

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Client Heather

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Heather secured a title loan to pay some crucial bills. This is another type of predatory loan that leverages a car title. If payments are not made, the car becomes property of the lender. Talk about pressure.

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She knew this wasn't a long-term solution, but had not read through the paperwork to see the true cost. Healther borrowed $2,500 against his car title at an interest rate of 311% over six months. The interest charge was $3,800, with a total cost of $6,300! Not only did the monthly payments cost over $600, there was a balloon payment at the end. Guess how much that final payment was? Over $3,000 that would be due all at once for the last payment. That's more than she received in the first place. Heather shared with me that she saw these advertisements on her phone and assumed they were safe and regulated by a credit agency. 

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How can you prevent the need for short term loans?

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People who rely on short term loans often feel they have no choice. It is important to get a snapshot of your current finances and see where you stand. Are there upcoming bills you need to plan for, such as bi-annual car insurance or HOA bills? Do you have a plan for special occasions such as holiday and birthday gifts? These can all be laid out in a budget with a trusted coach. Before you apply for a loan, see if you can increase your work hours or reduce your spending elsewhere. Can you borrow money from a friend or family member? There are other options that can be explored.

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What to look out for if you need to borrow

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No matter how badly you want to break free from short term loans, it takes time. If you are in a position where you have to take on debt there are some key points to review.

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1. The amount borrowed and how/when it's paid to you
2. Interest rate (usually expressed as an annual percentage, APR)
3. Term of the loan (amount of time to pay it back)
4. If there's a prepayment penalty (punishment for the company missing out on interest)
5. If there's a balloon payment at the end of the term

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If the documents you are given prior to signing do not have this information, avoid that lender at all costs. Take at least 24 hours to review the documents and share with a financial coach or trusted friend to review. Lenders should not pressure you to borrow. Finally, compare several loans with the points above before you make a final decision.

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If you teen has a phone, teach them to be wary

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Anyone with a social security number who is over the age of 18 can apply for a payday or short term loan. If your child is approaching adulthood, make sure you share with them the basics listed above. Teach them how to use a simple debit card before introducing credit cards. Risky loans like these can ruin your credit quickly, and financial literacy is barely covered in most schools. The online loan application has changed the landscape of access to vulnerable populations. The targeted marketing reminds me of when tobacco companies would stealthily market to younger groups to earn lifetime customers. Start the discussion early and bring in a financial professional when your teen is closer to leaving the nest.

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A quick fix is just a bandaid

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"How did I get here?" is the number one question my clients express to me. It seemingly comes out of nowhere that their finances do not align with their income. Emergencies and catastrophic events happen. However, consistent use of debt is a symptom of a bigger problem. Our coaches can help you make a customized budget that matches your unique life. A spending plan helps you intentionally use your hard-earned money, rather than life just happening to you. Consider a deep dive of past financial choices with a coach and evaluate how you can change your behaviors. Seek credit counseling to ensure your past debts have not affected your future financial health. A quick fix is exactly that: a quick (and temporary) fix.

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References

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Loftsgordon, A., & O’Neill, C. (2021). Solve your money troubles: Strategies to get out of debt and stay that way. Nolo.