Why Borrowers Use Payday Loans

People use payday loans to avoid borrowing from family and friends, and to avoid cutting back further on expenses. But they often end up doing those things anyway to pay back the loan, a new report finds.

The average payday loan — a short-term, high-interest-rate loan typically secured by a borrower’s future paycheck — requires a repayment of more than $400 in two weeks, according to a new report from an arm of the Pew Charitable Trusts. But the average borrower can only afford a $50 payment, which means that borrowers end up rolling over the loan and adding to their debt. The Pew report found that borrowers typically experience prolonged periods of debt, paying more than $500 in fees over five months.

About 41 percent of borrowers say they need a cash infusion to close out their payday loan debt. Typically, they get the money from the sources they tried to avoid in the first place, like family and friends, selling or pawning personal items, taking out another type of loan, or using a tax refund.

“Payday loans are marketed as an appealing short-term option, but that does not reflect reality. Paying them off in just two weeks is unaffordable for most borrowers, who become indebted long-term,” Nick Bourke, Pew’s expert on small-dollar loans, said in a prepared statement.

The Community Financial Services Association of America, a group representing payday lenders, countered that the Pew report lacked context. “Short-term credit products are an important financial tool for individuals who need funds to pay for an unexpected expense or manage a shortfall between paychecks,” the association said in a statement. “In our current economy and constricted credit market,” the statement continued, “it is critical that consumers have the credit options they need to deal with their financial challenges.” The typical fee charged by association members, the statement said, is $10 to $15 per $100 borrowed.

Payday loans and similar “bank deposit advance” loans, which are secured by a direct deposit into a bank account, are coming under increasing scrutiny from federal regulators.

Once confined to storefront operations, payday lenders are increasingly operating online. This last week, The New York Times reported that major banks, like JP Morgan Chase, Bank of America and Wells Fargo, had become behind-the-scene allies for the online lenders. The big banks don’t make the loans, but they enable the lenders to collect payments through electronic transactions.

(On Tuesday, though, Jamie Dimon, the chief executive of JPMorgan Chase, vowed to change how the bank deals with Internet-based payday lenders that automatically withdraw payments from borrowers’ checking accounts.)

The loans are typically viewed as helpful for unexpected bills or emergencies. But the Pew report found most payday borrowers are dealing with persistent cash shortfalls, rather than temporary expenses. Just 14 percent of borrowers say they can afford to repay an average payday loan out of their monthly budgets.

The findings are based on a telephone survey as well as focus groups, Information about borrowers’ experiences with payday loans is based on interviews with 703 borrowers. The margin of sampling error is plus or minus 4 percentage points.

Even though borrowers complained that they had difficulty repaying the loans, most agreed that the terms of the loans were clear. So why do they use such loans? Desperation, according to the report: “More than one-third of borrowers say they have been in such a difficult situation that they would take a payday loan on any terms offered.”

Have you ever used a payday loan? How did you pay it back?