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Stay Away From Payday Lenders

Dara Duguay Fall 2005

Content provided by InCharge Institute of America

For many people living on the edge, financial management is a constant battle between time and money: In any given month, is there "more month than money" or "more money than month?"

In other words, did your paycheck stretch long enough to last until your next paycheck?

When I lived in Los Angeles, my aspiring actor friend Jim was an expert at surviving when his money ran out. He had set up a dinner route that rotated restaurants where he would show up for free "happy hour" food. For the price of a beer, he would be able to eat at the unlimited dinner buffet. The nutritional value of the food - nachos, fried cheese sticks, buffalo wings - was questionable, but it served to fill his stomach.

Jim even resorted to sneaking into movie theaters through the exit in order to skip paying the price of the ticket. He justified this by saying that his chosen profession required constant monitoring of acting performances.

Jim was in search of another scheme when he saw a TV advertisement one night for something called a "payday loan." "No credit? No problem!" the ad proclaimed. It was exactly the type of sales pitch that appealed to someone living on the edge like Jim.

The next day, he showed up at one of the payday loan offices and was given two choices: He could write a post-dated check for the amount of the loan plus a fee, or he could assign his paycheck to the lender via electronic funds transfer and receive the amount of his paycheck minus an administrative fee. Jim chose to write a post-dated check. He got his money on the spot.

Jim had never planned on becoming a regular customer. He thought he would use the payday loan office as a backup whenever he ran short of cash. If Jim had looked honestly at his situation, however, he would have noticed that his cash shortage was an ongoing problem, not just an occasional one. In fact, Jim always ran out of money before his next paycheck arrived.

It never occurred to Jim to analyze his budget to understand how much his monthly expenses exceeded his income. Such a process could have helped him determine his options. If he was just a little bit short, he could have looked at eliminating or cutting down a few expenses. If he was a lot short, he could have looked at more drastic options, such as finding a roommate or another part-time job.

So Jim became a regular customer at the payday loan office. This source of money was so easy compared to his past schemes that he visited the office more and more frequently. Before he knew it, he had been advanced several paychecks instead of just one.

Jim didn't worry, because he believed his paychecks eventually would cover his post-dated checks. But then he wrecked his car. Lacking auto insurance - he had figured he would save money and take his chances - he now found himself in a predicament. Living in a car culture like L.A., getting around without a car presented quite a challenge.

Jim ended up buying a used car and financing it at a very high interest rate through the dealership. With the addition of high monthly car payments, he found it impossible to reimburse the payday loan company for the checks that he had been advanced. Before he knew it, the loan company's collection department was calling. Jim was able to work out a payment arrangement, but he was forced to get a job waiting tables while he put his dreams of an acting career on hold - perhaps forever.

Perhaps you have heard another name for payday loans, such as hold-a-check or payroll advance loans. But regardless of the name, the loans are hugely expensive when you realize that annualized rates of interest can run as high as 400 percent.

Like Jim, if you need your next paycheck now and can't wait until payday, a payday loan may look very tempting. But, in fact, you have just given yourself a fat pay cut.

In addition to the high fees and interest rates, it may be difficult to break the cycle of advancing from one payday loan to another once the pattern of borrowing starts. Breaking this dependency becomes as difficult as overcoming any other addiction.

It would have been so much easier to simply create a budget and stick to it!

Payday loans are advertised as solutions to short-term money problems. But in the long term, the damage they cause may prove devastating.

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Dara Duguay is director of Citigroup's Office of Financial Education and the author of several personal finance books.