Short-term payday loans are just not worth it

I had a hallelujah moment when I saw that the Consumer Financial Protection Bureau is proposing new rules that would require payday lenders to make sure that borrowers have the means to repay their loans.

I know. You have to be thinking what I’ve thought for years. Isn’t it the responsible thing for lenders to determine that people can pay the money back?

But because many people are still in a financial bind after paying off the loan, they end up taking out another loan. Repeat borrowing is good business for the lenders. The CFPB found that more than 80 percent of payday loans are followed by another loan within 14 days.

Payday loans are relatively small and are supposed to be paid back in full relatively quickly, typically in a few weeks. The lending requirements are pretty skimpy — a bank account and income. Borrowers can either give lenders post-dated personal checks or authorize an electronic funds withdrawal. The typical customer spends five months on the payday hamster wheel and pays $520 in fees for an original loan of $375, according to findings from the Pew Charitable Trusts, which has been doing great research on the dangers of these types of loans.

Payday loans are big business — $7.4 billion annually, according to Pew. Each year, 12 million Americans take out these loans from storefront locations, websites and a growing number of banks.

The CFPB proposal pertains to other types of loans, too, including auto title loans. Just as the name sounds, these loans are when individuals borrow against their paid-off cars. If a customer fails to repay a title loan, the lender can repossess the car. In a recent report, Pew said more than 2 million people use high-interest automobile title loans, generating $3 billion in revenue for lenders. The average title loan is $1,000. The average borrower spends an estimated $1,200 per year in fees.

Under the CFPB’s proposal, lenders would have to look at a person’s income and other financial obligations to determine his or her ability to pay the interest, principal and fees. The agency is also considering imposing limits on how many loans a customer can take out in a year.

I understand that people get into a financial jam and need help getting out. But if a short-term loan product weren’t available, they might manage their money in a way that doesn’t trap them into more debt.

Pew found that both payday and title-loan borrowers usually have other options, including getting the money from family or friends, selling possessions or cutting back on expenses.

Payday and title loans are the very definition of robbing Peter to pay Paul. Consider these facts from Pew:

The average lump-sum title loan payment consumes 50 percent of an average borrower’s gross monthly income.

A typical payday loan payment takes 36 percent of the borrower’s paycheck.

Borrowing against a future paycheck or putting up the title to your car is an incredibly unwise choice that can cause a financial avalanche. Even with better protections, just don’t do it.

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