Customers of Payday Lenders Can Be Forever in Their Debt

The 60-year-old North Carolina resident was behind on her electric bill and short of cash to buy presents for her grandchildren that year, so she applied for a short-term "payday" loan.

That mistake locked Monti into a cycle of twice-monthly borrowing that ultimately cost her $1,780 to repay $700 in loans -- thanks to an effective annual interest rate exceeding 400%. Before the matter was resolved, Monti required both credit counseling and a bailout from her church.

Monti's story is far from unique.

The payday lending industry, virtually nonexistent a decade ago, accounts for roughly $25 billion annually in loans, according to a recent study. More than 90% of payday loans are made to repeat borrowers such as Monti, whose short-term cash crisis was only worsened by the quick fix.

"I hated to see Fridays come because I knew I'd have to go to the bank, pull out all of my money to pay [the payday lender] and then get another loan to pay my bills," said Monti, a computer assembly technician. "It just got worse and worse."

Payday loans are deceptively simple short-term deals. The name comes from the fact that they're essentially a two-week advance designed to tide over the borrower until his or her next payday.

To get a payday loan, the borrower must have a job and a checking account. The borrower shows the lender a pay stub -- to prove he or she has a job and thus will get some cash within two weeks -- and then writes a postdated check to the lender. The check, which is for the amount of the loan plus a fee that usually amounts to 15% of the loan amount, serves as security for the loan.

If the borrower doesn't return to repay or renew the loan by the date on the check, the check is presented at the borrower's bank for payment. If the balance in the borrower's account can't cover the check, the borrower faces bounced check fees from the bank and the payday lender.

Unfortunately, borrowers who are so strapped for cash that they can't make it to their next paycheck probably won't be able to pay off the loan within two weeks, especially after paying the loan fee, said Jean Ann Fox, director of consumer protection for the Consumer Federation of America.

Consequently, most borrowers end up renewing the same loan multiple times. Each time the loan is renewed, the fee must be paid again, she said.