A few years ago, my wife and I got a nice big aquarium and filled it with fish.   Not long ago — probably because of a new PetSmart in the big-box zone — the local fish store we visited went under.  Last week I looked at the small building it used to occupy, and found it occupied by a payday loan service.  

Shortly thereafter, I noticed yet another payday loan shop — proudly announcing its grand opening — along a generally nice, tree-lined section of Main Street near our library, police station, and main post office.

What are these businesses?  The latest in a long line of businesses that make the cost of poverty outrageous.  And to make things worse, some businesses in that line used to be more reputable — like your neighborhood’s banks.  More below.
1: The New Breed of Loan Sharks…

How do payday loans work?  Pretty simple, really.  You borrow some money.  You present the lender a post-dated check, worth the value of the loan plus some interest.  On the date of the check, usually 1 to 2 weeks in advance and on or shortly after your next payday, the lender cashes the check.  

In addition to the loan, you get a lovely debt treadmill with the lender’s name scribbled on it.  Not stamped or engraved; they’re too cheap for all that. You are probably already aware of the ridiculous interest and fees charged (often $25 biweekly on a loan of $100).  If you can’t repay $100 on two weeks’ notice or so, you probably won’t be able to come up with the full $125 by then either, so you keep paying $25 every two weeks for a very long time.  The debt treadmill picks up speed, and you’re off on a wild ride.

2:  …Everyone Else Gets Into the Water, Too

If you’re savvy about your finances, you realize that credit-card cash advances are not only not free, they’re a form of the debt treadmill that I’ve been referring to here, just somewhat less crazy than the payday loan variety.  Same thing for places like this.  Even so, your average bank offers a lot of schemes that make pawn shops and credit-card cash advances look downright sane.

My current bank offers “direct deposit advances”, at  $20 for each $200 borrowed.  Functionally it’s no different from a credit-card cash advance paid in full with the next paycheck.  However, a $200 advance on a credit card won’t rack up $20 by the next paycheck.  It’d be more like $6 – $8.  If you’re reasonably wealthy, and have a temporary cash flow problem, you might pay the extra for convenience, knowing it’s a one-time deal.  But if you’re poorer and come close to running out of money each month, so you do direct-deposit advances month over month, it’s treadmill time, only this time with your bank’s name written on the front.

Even worse are “bounce protection” schemes.  If you’re not careful, the bank lets the overdraft go through — and duns you $25 or more per overdraft, plus daily fees, till you bring your account into the black.  Of course, since you’re “protected”, the bank doesn’t warn you when you’re about to overdraw, even though ATMs and point-of-sale boxes are smart enough to do that, so you can easily overdraw four or five times before realizing there’s a problem.  $200 of overdrafts ends up costing way more than $200 of credit-card cash advances (or just about any other loan, short of payday loan sharkery).  Again, if you come close to running out of money each month, you’ll probably hit these fees over and over again.  Same damn treadmill, again with the bank’s name on the front.  

Tax preparers have their own scam:  refund anticipation loans.  Not as much of a treadmill, since it’s just once a year, but every year, a huge chunk of a valuable refund goes out the window.  Even excluding the tax preparation and filing fees, the fee for the refund anticipation loan is much larger than the fee for a credit card cash advance for the same amount.  

3:  Higher and Higher

Thanks to the treadmill, many people can’t avoid using services like these over and over again.  So it’s entirely fair to treat them as a sort of long-term credit and figure out annual percentage rates for them.  The APR for loans like these — payday loans, overdraft loans, tax refund anticipation loans, and so on — can be over 300%.  It’s difficult to appreciate the differences verbally between loans like this and more conventional loans, so consider this chart as well:

4:  That’s Interesting…

Let’s compare two short-term loans from a major bank:

  1. about to run out of funds in checking, I borrow money using a conventional unsecured credit line (about 10% – 15% APR)
  2. about to run out of funds in checking, I borrow money by letting the bank send checking overdrafts through, at a fee (over 300% APR)

Where do these huge APR differences come from?  Damn good question.   Interest rates traditionally reflect 4 factors:  1) some baseline cost of borrowing, which is closely tied to the federal funds rate the Federal Reserve sets; 2) an estimate of inflation, so the loan gets repaid in effectively constant dollars; 3) an estimate of risk to the lender; and 4) some profit margin for the lender.  

At any given time, for these two loans, 1) and 2) are essentially the same, and 3) is probably lower in things like overdraft protection schemes, since the bank will automatically take a full repayment of the overdraft (plus all fees) from the next deposit, whereas the bank probably doesn’t expect payment in full on the credit line in such a short time.

5:  Debt Inequality:  Worse than Income Inequality

Having ruled out the other three components of interest, we’re left with the profit margin.  Banks, however, make a perfectly good profit on well-established, traditional loans — lines of credit, home loans, car loans, and so on.  Lots of profit:  my home loan, every month, is probably worth dozens of cash advances and overdraft fees.  However, unlike those loans, which are primarily for middle-class and wealthier people, these fiddly predatory fees and loans are aimed at poor to lower-middle-class people.  

Worse, these loans and fees keep people poor.  Wealthy people often say “well, they should just be careful, read the fine print, and stay away from bad forms of credit”, but when the best lenders in town are no better than a pawn shop or a credit card, how exactly does one stay away?  Sad to say, the only real way to “stay away” is to be more wealthy — at least, not be forced to live paycheck to paycheck — so you have more savings and more access to better forms of credit.

War is Peace, Ignorance is Strength … and Poverty is Wealth — lots of it — for too many lenders.

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