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Beware of Payday Loans

December 29, 2004

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Illinois Attorney General Lisa Madigan is warning consumers to be wary of the many advertisements appearing in newspapers and on the radio touting low-cost payday loans during the holiday season and trying to lure in customers with items ranging from t-shirts to free turkeys.

Madigan said while these short-term loans may seem to be the answer to a cash crunch, they come at an incredibly high cost to the consumer.

Madigan noted the media is filled with advertisements and offers of extended hours during the holiday shopping season because they know this is the time of year when people need extra cash. However, what the payday lenders don’t advertise about the loans are the enormous cost of taking out such loans, loan terms that enable the lenders to dodge regulations set by state law, and annual percentage rates (APR) that often are well above 250 percent.

“During the holiday shopping season, consumers are flooded with a deluge of advertisements for payday loans appearing in the newspapers and on the radio,” Madigan said. “I recently saw a payday loan ad offering free turkeys and another shop is offering free t-shirts that say ‘It’s better than borrowing from your mother.’ The reality is that these loans will take the shirt right off of your back with costly fees and outrageous interest rates.”

A payday loan is a short-term loan obtained when a borrower writes a check dated in the future. To get a loan, a borrower must show the payday lender a pay stub and then write the lender a check for the cash loan. The check is usually made out for a later date – often one month and one day after the date of the loan. The lender gives the borrower cash in return, but for an amount less than the value of the check.

The difference between the amount for which the consumer writes the check and the amount the consumer is paid in cash is the lender’s profit, or finance charge. Payday l enders often charge between $15 and $50 for every $90 borrowed, which only covers the few short weeks of the loan term. After that, the consumer must pay the lender back or pay the lender even more in finance charges.

Most of the time, a consumer doesn’t have the funds in his or her checking account to cover the post-dated check when it is written, and may not have the funds when it comes time for the check to be cashed. When payment comes due, if consumers can’t cover the check, they are often encouraged to roll the overdue loan into a new loan, incurring new fees and increasing the amount of the loan. This loan “flipping” easily can lead to the consumer using most or all of the money borrowed to pay the lender’s costly fees.

Madigan said the Truth in Lending Act gives consumers the right to know the cost of any type of credit they apply for, including payday loans. Therefore, the lender is required to provide in writing both the APR and the dollar amount of all applicable finance charges.

While the Illinois Department of Financial and Professional Regulation regulates payday loans, payday lenders have found clever ways around the rules. For example, the industry dodges the rules by writing loans for 31 days or more, when the loans covered by state regulations have a 30-day limit on the loan term.

Madigan reminded consumers there are some community banks, credit unions and small loan companies that compete for consumer business by meeting their needs without making them pay exorbitant fees and interest rates. These banks will make short-term loans at comparatively low interest rates, and they require little more paperwork than the payday lenders to qualify the consumer for the loan. These lenders may prove to be far more affordable for the consumer when it comes to paying back the loan.

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