You need cash to pay an important bill, and you haven't got it. What do you do?
Many Americans turn to payday loans to fill this gap, even though the interest rates are staggering – an average of nearly 400% APR.
A recent survey by CNBC Make It and Morning Consult found that all generations use payday loans. While 11% of all Americans have taken out a payday loan over the last two years, millennials (22 to 37 years old) and Generation Xers (38 to 53 years old) rely on payday loans the most. Thirteen percent of both generations have taken out payday loans over the past two years, compared to 8% of Generation Z (18 to 21 years old) and 7% of baby boomers (54 to 72 years old).
A disturbing percentage of young Americans have at least considered the idea. Over half of millennials (51%) have considered a payday loan – not surprising, given that many millennials came of age during the housing crisis and the subsequent recession. The most common reason cited was to cover basic expenses like rent, utility payments, and groceries.
However, 38% of Generation Z have also considered taking out a payday loan. Their reasons were mostly associated with college costs (11%).
Older generations see the downsides of payday loans – or perhaps they experienced those downsides when they were younger. Only 16% of Gen Xers considered a payday loan, while only 7% of baby boomers did so. (Essentially, any baby boomers desperate enough to consider a payday loan followed through.)
What are the drawbacks of a payday loan? Interest rates are a huge drawback. Payday loans are relatively small loans paid over a short period of time, and to hide the impact, the payback is typically expressed in dollars. For example, a two-week loan of $100 may come with a finance charge of $75. That sounds reasonable – until you realize that the finance charge equals an approximate 1950% APR.
Lenders often roll over the loan for those who can't pay, further compounding the problem. According to the Consumer Financial Protection Bureau (CFPB), almost 25% of payday loan borrowers re-borrow their loan at least nine times. The Pew Research Center found that an average payday loan borrower took out eight loans of $375 each annually and paid $520 in interest as a result.
Contrary to a popular myth, payday loans won't help your credit score if you pay them back on time. Payday lenders don't report payment information to the credit bureaus. However, a payday loan could actually hurt your credit score if your loan goes into collections. You can check your credit score and read your credit report for free within minutes by joining MoneyTips.
If you decide to seek a payday loan, you probably won't have much trouble finding one. There are around 23,000 payday lenders in the U.S. – although some states ban the practice and others limit the effect of payday loans by setting usury limits or interest rate caps. The Consumer Federation of America provides details of each state's payday loan policies on their website.
The CFPB has issued rules for payday loan regulations to take effect in August 2019 – but there's no guarantee of follow-through.
Even in states with regulatory limits, a payday loan should be a last resort. Consider alternatives such as negotiating payment schedules with creditors, borrowing from friends or family, getting an advance from your employer, or taking out a small personal loan. If you are interested in a personal loan, visit our curated list of top lenders.
Better still, work enough surplus into your budget to create an emergency fund for future financial crises. You won't have to worry about any loan repayment at all.