Payday Lending: How the Debt Trap Catches Borrowers

Five million Americans have been caught in the trap of payday lending.

Before making a loan, legitimate lenders assess the ability of potential borrowers to repay it. Payday lenders do not. In fact, their business is built on making loans borrowers cannot afford to pay off, so that they will keep coming back and paying repeated fees on the same small amount of money borrowed. CRL's 2006 study of the payday lending industry shows that this business model costs Americans an estimated $4.2 billion annually.

To obtain a loan, a borrower gives a payday lender a postdated personal check or an authorization for automatic withdrawal from the borrower’s bank account. In return, he receives cash, minus the lender's fees. For example, with a $300 payday loan, a borrower might pay $45 in fees and get $255 in cash.

The lender holds the check or electronic debit authorization for a week or two (usually until the borrower's next payday). At that time the loan is due in full, but most borrowers cannot afford to pay the loan back and still make it to the next payday.

But if the check is not covered, the borrower accumulates bounced check fees from the bank and the lender, who can pass the check through the borrower’s account repeatedly. Payday lenders have used aggressive collection practices, sometimes threatening criminal charges for writing a bad check even when state law prohibits making such a threat. Under these pressures, most payday borrowers get caught in the debt trap.

To avoid default, they pay another $45 to keep the same loan outstanding, or they pay the full $300 back, but immediately take out another payday loan, with another $45 fee.

In either case, the borrower is paying $45 every two weeks to float a $255 advance – while never paying down the original amount of the principal. The borrower is stuck in a debt trap – paying new fees every two weeks just to keep an existing loan (or multiple loans) outstanding.