Dear Money & Crisis Reader,
Yesterday we met a couple whose life was ruined by a $500 loan.
That type of loan is known as a “payday loan.”
No doubt you’ve seen the brightly colored commercials on TV or in your local paper advertising these seemingly convenient, short-term loans.
They promise “fast cash” with “no credit checks.” But what they don’t tell you is that these loans are structured to:
- Hide the true cost of the loan in the small print, and
- Interfere with your ability to repay the debt, causing you to rack up expensive fees and interest which can be as high as 300—1,000%.
Back in 2013, Texan David Myers took out a $750 payday loan to pay a deposit on his new apartment.
When he couldn’t repay the loan (along with $200 in fees) he did the only thing he could think of… he took out another payday loan.
And when the time came to repay that loan… he took out another. And it only snowballed from there.
“They don’t tell you about the fees,” says David. “At one point, I realized I was paying $800 a month just in fees… for a $750 loan! How does that make any sense?”
Eventually the snowball of debt was a boulder… and David couldn’t outrun it any longer.
He started to miss repayments… and this is where payday lenders really make their money.
They foreclosed on David’s home and kicked him out into the street.
Three years later, David is still homeless… and it all started with that $750 loan.
The Defense for Payday Loans
Now, advocates of payday loans (see: loan sharks) will say that these short-term loans are a financial tool just like any other.
All folks have to do is pay them back the day they get paid, along with any fees they owe, to avoid racking up interest.
But using a payday loan to pay your bills is like using a flamethrower for yardwork. (Sure it will probably kill some weeds, but if you don’t know what you’re doing, you’re going to lose your house as well.)
And that’s because predatory lenders employ a suite of deceitful tactics and strategies that hamper your ability to understand and repay your loan.
According to the Consumer Financial Protection Bureau (CFPB), 80% of payday borrowers have to roll over or reborrow loans within 30 days. Twenty percent of borrowers default on their payday loans… while folks who borrow online default at a rate of more than 50%.
To put that into perspective, the S&P/Experian Consumer Credit Default Composite Index — which tracks first and second mortgages, auto loans, and bank cards — reported a default rate of just 0.91% in 2017.
The good news is, if you know what to look for, you can spot a predatory money lender a mile off.
Walk away from the table if you see any of these red flags:
Red Flag #1: The money lender tells you to lie on your application
They’ll try and pass this off as “helping you out.” But there’s always an ulterior motive. For example, if you say your income is higher than it really is, you can get approved for more money.
Now, that might sound great. But what they’re trying to do is force you to borrow more money than you can afford to pay back, trapping you into a long-term repayment plan with sky-high interest rates and fees.
Red Flag #2: The terms of the loan are unclear to you
If you can’t tell exactly how much a loan is going to cost you right away, it’s because the documents are structured to hide that from you.
All fees and interest rates should be listed upfront. And the interest rate should always be in terms of APR (annual percentage rate).
You also need to know if there will be any balloon payments or penalties for early repayment and what happens if you make a late payment. If the money lender avoids answering these questions or gives you confusing answers, walk away.
Red Flag #3: Getting “approval” is too easy
Predatory lenders don’t care if you’re able to repay your loan or not. In fact, they’d much prefer that you’re not able to. That way, you get stuck in their system for years, paying high interest rates and borrowing over and over again just to get by.
If someone approves your loan without requiring documentation or checking your credit score, you’re dealing with a predator who stands to profit when you fail to pay off your loan.
Red Flag #4: Forms have blank spaces throughout
If a form has blank spaces throughout, you’ve got yourself a ruthless loan shark on your hands. After you sign those documents they can add anything they want to the contract in those blank spaces. And you can be sure it will be nothing good.
Often predatory lenders will also refuse to give you a copy of the document. That way if they want to change the terms of the loan, they can simply edit in extra paragraphs or even whole pages. Without a copy of the document, you have no way of proving the contract had been changed.
The bottom line is if a loan agreement seems too good to be true, it is. But if you keep an eye out for these red flags, they’re not going to catch you sleeping.
As always, if you have any questions, ideas or a predatory loan story of your own, click here to email me. I’d love to hear from you.
All the best,
Editor, Money & Crisis