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How payday loans lead to long-term debt

A new report says that a borrower remains in debt to the payday lender for more than half a year on average.

By MSN Money Partner Apr 4, 2011 1:43PM

This post comes from Jeanine Skowronski at partner site MainStreet.

 

Cash-strapped workers may think taking out a payday loan to cover expenses until the next paycheck is a minor risk, but a new study suggests that these borrowers aren't incurring just a short-term debt.

 

According to the consumer watchdog group Center for Responsible Lending, payday borrowers actually remain in debt, on average, for more than half a year, despite the fact that a payday loan typically must be repaid within two weeks. Post continues after video.

As MainStreet has previously reported, a consumer in need of fast funds gets a payday loan by giving the lender a post-dated check in exchange for some cold, hard cash. But the advance typically has an astronomical annual percentage rate (sometimes around 400%) or other high fees associated with it.

As such, when the lender takes the full amount of the loan from the borrower's next paycheck, little is left for borrowers to manage daily living expenses and, invariably leads to another payday loan. According to the data, the typical $300 for an initial payday loan increases to $466 by the time it is to be paid back.

 

"This new report finds even more disturbing lending patterns than our earlier reports," Uriah King, a senior vice president with CRL, said in a written statement. "Not only is the actual length of payday borrowing longer, the amount and frequency grows as well. The first payday loan becomes the gateway to long-term debt and robs working families of funds available to cover everyday living expenses."

 

Researchers at the CRL tracked transactions for 11,000 borrowers in Oklahoma over the course of two years, focusing on borrowers who took out their first payday loans in March, June or September of 2006.

 

High default rate

Oklahoma was selected because it's one of the few states where a loan database makes this kind of analysis possible. CRL then compared these findings with available information from regulator data and borrower interviews in other states.

 

It found that in the first year after taking out a loan, the average borrower was in debt for 212 days. Over the full two-year study, the average length of borrower indebtedness grew to 372 days.

 

Additionally, 44% of payday borrowers ultimately have trouble paying their loans and end up defaulting, which typically incurs additional fees from the payday lender but also can lead to overdraft fees from the borrower's bank.

To address the problem, the CRL recommends that states that allow payday loans to be offered at triple-digit rates institute interest rate caps at or around 36% annually, something that has already been done successfully in 17 states and the District of Columbia.

 

It also suggests that state regulators and the new Consumer Financial Protection Bureau also consider limiting the amount of time a borrower can remain indebted in high-cost payday loans and requiring sustainable terms and meaningful underwriting of small loans in general.

 

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