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Avoid Payday Borrowing

by Darla Dernovsek

Getting a payday loan to solve your cash-flow problem is like poking a hole in the pocket where you carry cash. It may take a while for the size of the problem to become apparent, but over time your money is apt to disappear.

Research shows that getting your first payday loan is the equivalent of putting your foot in a trap.

Many consumers-including many "middle class"-are lured into that trap by payday lenders' promises of quick and easy access to cash. This includes banks and fringe providers.

The rollover trap

What payday lenders neglect to mention is that if you can't repay the full amount of your loan when it's due, you'll be forced to take out another loan for the amount you originally borrowed, plus the interest and fees charged on both the original loan and the new loan.

The average borrower is forced to "roll over" the original loan this way at least eight times before he or she can afford to repay the full amount, according to the Center for Responsible Lending.

For most borrowers, that means the amount owed to payday lenders quickly grows, often reaching double or even triple the amount originally borrowed. Center for Responsible Lending studies show the average payday borrower spends $793 to repay a $325 loan.

The majority of payday loans made go to repeat borrowers.

Find an alternative

Payday borrowers who live or work in a community served by a credit union already may have access to an alternative.

Credit unions typically offer products that can help their members overcome cash-flow shortages as they move from payday to payday.

A short-term credit union loan can generate significant savings.

"Generally, credit unions are looking for ways to provide a product that will get the member out of the payday lending trap," says Lois Kitsch, national program manager for REAL Solutions at the National Credit Union Foundation, Washington, D.C.

The REAL Solutions program helps credit unions develop solutions for people who have modest means, including those who struggle from paycheck to paycheck.

Credit unions know this struggle worsens when members give in to the temptation to use a payday lender.

Stop now

If you're already straining to repay a payday loan, it's time to take drastic action.

"First and foremost, get that loan paid off right now, no matter how hard it is," Kitsch advises. "Look for another alternative from traditional lenders. Go to your credit union, tell them your situation, and find out what they can do for you."

Credit unions typically can help members with two types of loans. Some credit unions have created low-cost, short-term loans that have some of the same features as payday loans, such as gaining quick approval and paying a flat fee.

Other credit unions help members escape the payday lending cycle by offering a slightly larger loan for a longer period of time, such as six months to a year. This allows the member to repay the loan with a series of small payments instead of a single, large payment that busts the budget.

Paying off a credit union loan has a bonus: It can help improve your credit score so you qualify for lower loan costs in the future. In comparison, repaying payday loans has no benefit on a conventional credit score. The FICO Expansion Score uses nontraditional credit and payment histories when calculating credit scores, but not all lenders use it.

Look at the events that prompt your need for quick cash.

Even if you're not a credit union member, Kitsch says most credit unions can direct you to alternatives in your community.

If you're not a member, chances are there's a credit union that you're eligible to join. For example, you may be eligible to join the credit union on whose Web site you're reading this article.

What you save

Using a short-term credit union loan instead of a payday lender can generate significant savings for members. Costs and services will vary, based on the credit union's program and state laws.

Credit unions in some states are working together to establish short-term lending programs to deliver alternatives to more members.

The StretchPay program developed by Ohio credit unions charges between $3 and $4 per $100 borrowed for short-term loans, based on the average Ohio payday borrower's use of nine loans per year. That compares with a cost of $15 per $100 for borrowers who use state-licensed Ohio lenders who are forbidden to roll over loans, with online lenders and lenders licensed by other states charging even more.

The StretchPay program includes financial counseling and education and is now available from credit unions in several states and the District of Columbia.

If you have a payday loan, it's time for drastic action.

Other options

Kitsch notes that you might be able to avoid borrowing altogether by checking out options for obtaining free services or paying for services over time. She suggests asking questions about what's available locally.

"If I need medicine, is there a free clinic I can go to that will supply that medicine?" Kitsch says. "If my car has broken down, can I go to a mechanic who will let me pay in three monthly installments, instead of taking out an expensive loan to pay it all at once?"

Other solutions for meeting money shortfalls or repaying loans include reducing expenses by taking a hard look at what's a necessity and what's an extra; selling possessions that aren't being used and generating extra income with a second job or overtime hours.

Setting goals

Once you win free of a payday loan, "Do not go back to the payday lender," Kitsch warns. Returning to a payday lender simply starts the cycle again.

Instead, take a look at the costs or events that prompted your need for quick cash and figure out another way to handle them.

For example, Kitsch says that parents sometimes turn to payday lenders in late summer when children need school clothes and supplies and schools demand payment of annual fees.

You can change that approach by asking your credit union about programs that help you establish savings or even automatically deposit some of your earnings directly in a savings account.

Another option many credit unions offer is a "goal setter" account. Sometimes called Christmas club accounts, these savings programs help members set aside a certain amount every month to be ready for a specific event, such as the start of the school year.

A long-term view

It's also important to examine your needs for a full year, rather than month by month, which should motivate you to start saving now for emergencies.

While it may be impossible to predict when a refrigerator will break down or an aging vehicle will finally shudder to a halt, it's reasonable to assume that over the course of a year, breakdowns will test your budget.

"Learning to put a little money aside for a future life event is very important," Kitsch notes.

Putting those funds in a credit union savings account will help you resist the temptation to tap the funds when you're short of cash.

Equally important, you can ask a credit union staff member about ways to improve your credit score, which helps you qualify for loans with better terms and lower costs so you can stay out of the payday lending trap for good.

"It's going to take discipline, but you can improve your financial future," Kitsch says.

Published 08-23-2012.


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