When would it make sense to use a payday lender or cash advance store?

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Payday loans and app-based cash advance services allow you to borrow against your next paycheck to meet your financial needs today. But because of their high borrowing costs, these services could do more harm than good.

Annual percentage rates for short-term payday loans, for example, are determined by a patchwork of state-level restrictions, and payday loan APRs frequently reach three figures—in some cases, four figures. By comparison, the average APR for credit cards so far in 2020 is 15.09%, according to the Federal Reserve.

In recent years, traditional payday loan usage has been on the decline, but a new breed of app-based cash-advance lenders is filling the void. With incomes down during the COVID-19 pandemic, consumer advocates worry that people might flock to predatory financial services.

“People turn to them because they don’t have enough money,” says Lauren Saunders, the associate director of the National Consumer Law Center, a nonprofit consumer-advocacy organization. But if you’re working fewer hours, an advance or a loan doesn’t give you any extra money, she says. “It just makes next week worse. The COVID situation really highlights the weaknesses of these programs.”

Despite the risks, some consumers see them as the only option in tough financial situations. Here’s everything to consider before taking out a payday loan or using a cash advance app—plus funding alternatives and financial strategies to help you avoid both of them.

Cash Advance vs. Payday Loan

From a consumer’s perspective, payday loans and cash-advance services share more similarities than differences. Both services promise quick cash when you’re in a bind by providing the opportunity to borrow money you can repay from your next paycheck.

“The biggest difference is pricing,” Saunders says, noting that payday loans are notorious for high annual percentage rates. But the fees and voluntary payments commonly charged by earned-wage services, also known as “tips,” shouldn’t be ignored.

Traditional payday loans have a long and controversial history in the U.S. Over the years, lawmakers have tightened and loosened restrictions on lenders by enacting regulations that specify allowable loan term lengths and maximum financing fees. Despite regulatory efforts to limit them, payday loans are still legal in most states. And some states have no explicit interest caps at all.

App-based cash advance services, however, are a relatively new concept. The services are also referred to as earned-wage, early-wage or payroll advances, which are often provided by fintech startups, not traditional payday lenders. Most major providers, including Earnin, PayActiv and Dave, have sprouted up within the last decade.

Instead of charging loan financing fees, earned-wage advance services like Earnin and Dave prompt users to tip on their “free” cash advance. Earnin suggests tips in dollar amounts, up to $14 per advance, whereas Dave suggests a tip between 5% and 15% of the total advance. PayActiv markets itself to employers as a payroll benefit and makes money through membership and service fees.

Payday services appeal to the most economically vulnerable populations. More than 8.9 million American households used alternative financial services, including payday loans, in the past 12 months—and they’re disproportionately lower-income earners, according to the most recent survey data available from the Federal Deposit Insurance Corporation (FDIC).

Consumer advocacy groups say people rely on payday loans and payroll advances for the same reason: They don’t have enough money now and need help to make it through the next couple of weeks. Instead of helping, the advances or loans kickstart what consumer advocates frequently call a dangerous “debt trap” or “cycle of debt.”

“If you run out of money and you borrow against your next paycheck, you’re very likely to have a hole in your next paycheck,” says Saunders. “That will make it hard to make it through the next pay period without borrowing again.”

That spiraling effect can result from both earned-wage advances and payday loans.

What to Know About Payday Loans

According to nationwide data compiled by the Consumer Federation of America, 31 states allow payday lending. The remaining 19 states and Washington, D.C. have regulations that either explicitly or effectively prohibit payday loans in the traditional sense—as a two-week, high-interest loan.

However, four states have no interest-rate caps at all, and one state allows a 1,950% APR for a $100, 14-day loan: Missouri.

How does the APR of a payday loan get so high? It’s all in the math. APR looks beyond simple percentages and factors in time. For example, a consumer in Missouri may be in a pinch for cash and need a two-week loan to tide them over. They take out $100 now, and the lender charges a $75 fee when payday comes around. At first glance, it may appear the interest rate is 75%. That’s because time isn’t factored in.

The true cost of payday loans should be measured in annual percentage rates. A seemingly small fee for borrowing money could skyrocket the APR because the length of the loan is so short.

Payday loans are often marketed toward consumers in need of quick cash, and they are generally easy to receive compared to other financial services. In many cases, consumers only need an ID, proof of income and a bank account to get approved. Lenders often skip over credit checks and approve applicants quickly.

The fast cash may sound like a solution, but it tends to establish a cycle of dependency. Consumer advocates recommend them only as an absolute last resort—or not at all.

“The research on payday loans has shown time and time again that there is more harm than good that could ever be in this product,” Charla Rios, a payday-loan and predatory-debt researcher at the Center for Responsible Lending, wrote in an email.

Though for many consumers, that’s common knowledge. As a result, they’re turning to fintech alternatives.

What to Know About Cash Advance Apps and Services

The two most popular cash advance apps, Earnin and Dave, position themselves as alternatives to predatory payday lenders—as the good guys, according to consumer advocates.

“They are using marketing right now to appeal to consumers and potential borrowers as the friendly neighborhood figure,” Rios says.

Earnin, for example, offers advances between $100 and $500. To qualify for an advance, users have to provide much more personal information than a payday loan. The app requires users to provide access to their bank accounts, so Earnin can analyze pay history and other factors.

Over the course of an approved advance, the app tracks user GPS data to ensure a borrower is physically going to their workplace. Then, once payday hits and the direct deposit drops, Earnin automatically deducts the advanced amount. No interest. No fees.

So what does Earnin collect? Voluntary tips, between $0 and $14 per advance. But the phrase “voluntary tips” could confuse consumers.

For instance, the word “tipping” might lead you to think in terms of gratuity and etiquette associated with the service industry—and less so in terms of predatory APRs. Tipping your Postmate for a speedy delivery is very different from tipping on a cash advance.

Saunders took aim at a different word: voluntary.

“In the past, it hasn’t turned out to be so voluntary,” Saunders says, referring to a practice that Earnin discontinued using.

According to a report by the New York Post, as recently as September 2019, Earnin would limit advance amounts to New York residents who didn’t tip. The Post reported that Earnin ditched the practice due to an ongoing investigation by the New York Department of Financial Services (NYDFS).

In March 2019, the NYDFS launched a probe into whether Earnin and similar earned-wage lenders are violating small-loan rate caps. By August 2019, 10 states and Puerto Rico joined the investigation.

Critics and investigators argue that the tip could exceed predatory lending caps and skirt state regulations.

“A $100 advance taken out five days before payday with a $5 fee or ‘tip’ is equivalent to an annual percentage rate of 365%,” the National Consumer Law Center wrote in a March report on earned-wage advances.

Potential APR issues aside, both Rios and Saunders warn payroll advances can lead to a cycle of debt just like payday loans.

“Accessing future earnings does not remedy the original cash shortage problem,” Rios says.

Earnin declined to comment on how frequently its users request advances or leave tips, or on how tips compare to predatory loan APRs.

How to Get Out Of Payday Loans

Getting out of a payday loan debt trap can be challenging—but it is possible. One option for getting rid of payday loans is consolidating them with another low-interest debt vehicle.

For example, you could apply for an installment loan and use those funds to pay off the payday loans. This would transfer your debt from the payday lender to a personal loan lender, which could lower your payment and save you money on interest and fees. Payday alternative loans (PALs) offered by credit unions are a type of affordable installment loan to consider for consolidation.

Another option for paying off payday loans is asking the lender for an extended payment plan that spreads out payments over several months. Extended plans can make payments easier to manage since you won’t have to scramble to repay your debt within a pay period.

Borrowing money from friends or family could be a last resort if you’re in a tight spot. Rolling over payday loans to new terms when you can’t pay can be costly, and using a peer loan could help you avoid future fees racking up. Just make sure that you and whoever is lending you the money are in agreement about the terms of repayment.

How to Avoid Payday Loans and Cash Advance Loans

Financial crises are sometimes unavoidable, but how you react to them is under your control. The consensus is pretty clear: Avoid both payday loans and earned-wage advances, as either one could trigger a long-term debt cycle. The Consumer Financial Protection Bureau recommends several steps you should take before you borrow from your next paycheck.

• Reach out to nonprofit organizations, community support groups, employers or friends and family for assistance

• Lower your payments due by negotiating with your creditor or debt collector

• If you have a solid credit history, contact your bank or credit union to apply for a credit card that have interest rates much lower than typical payday loans
• If you’re not in dire financial straits currently, start now on an emergency fund to beef up your contingency plan

Beyond that, “avoid any promises of quick cash or places that do not look at any ability to repay loans,” Rios says.

If you’ve exhausted all options, Saunders says to consider earned-wage or payroll advances before taking out a payday loan. Ideally, she says, the advance would be through companies like PayActiv, which provide the payroll services through your employer.

She warns that the direct-to-consumer versions like Dave or Earnin should be entertained only if you know that your next pay period will be larger than normal. This prevents an income hole in your next paycheck.

“If you’ve got a stimulus check coming next week, and you know you have extra money coming in, it’s probably not a huge problem to take an advance. But that’s an unusual situation,” Saunders says.

She notes the new breed of fintech payroll lenders may appear to be harmless, but they are “for-profit, moneymaking ventures” that aren’t providing the advances out of the goodness of their hearts.

Frequently Asked Questions (FAQs)

How many payday loans can I get?

The number of payday loans you can get may vary by lender and state. Some states limit the number of payday loans you can have per year. For example, in Washington state, you’re limited to taking out up to eight payday loans every 12 months.

Check with your lender or state to see what rules apply to you, but also consider that taking out multiple payday loans can lead to a vicious debt cycle. Even if you can take out several loans, keeping payday loan borrowing to a minimum can help you avoid getting into financial trouble.

How do you find out if you have outstanding payday loans?

The first place to double-check for outstanding payday loan debt is your credit reports, which you can get for free at AnnualCreditReport.com. While payday lenders typically don’t report payday loan accounts to the credit bureaus, unpaid loan balances sent to collections could show up in your credit history. It’s also a good idea to contact lenders you borrowed from directly to identify unpaid debt for loans that might not be showing up on your reports.

How do you pay off multiple payday loans?

Consolidating payday loan debt using an installment loan can save you money on fees and make payments more manageable. Aside from debt consolidation, making extra payday loan payments if you have spare cash or requesting an extended payment plan could help you get out of debt faster.

What is one of the benefits of a cash advance or payday loan?

What are the benefits of using payday lenders?

Who typically uses a payday lender?

What is the difference between cash advance and payday loan?