Payday pitfall to avoid at all costs

Okay, we've all been there.  Payday is next week, but you have an unexpected bill and you need money now.  Luckily (not) for you, there are a plethora of companies willing to give you an advance on your next payday.  They make it seem simple, easy, and smooth.  You take in a pay stub or two, provide them with your account number and routing number, and they'll electronically deposit some money into your checking account quickly.  You'll sign a repayment agreement and walk out with the money you need when you need it.  Can't lose, right?  WRONG.

Payday loans are the arch nemesis of any person who is trying to build or establish a strong financial background.  And the companies who provide them are often sneaky and underhanded in their business practices.  I can't stress it enough... payday loans should be avoided at ALL COSTS.  Why?  Well, there are a few reasons...

1) Cost
Alright, we're just talking financial cost, here... not including the safety, security, and emotional costs you may pay if you fall victim to the payday loan pitfall.  When you advance the money, there is a service fee charged to perform the service.  Depending on the payday loan company, this fee can be upwards of 50% the original transaction amount.  So, if you borrow $200... you could end up paying $100 out of pocket... just to receive the service.  Even the least expensive payday loan companies charge something close to $5 for every $20 advanced... so you pay a quarter of what you borrow, which is just ridiculous.  That's like paying 25% interest on a loan... who would do that?

2) Concept
Payday loans were created and marketed originally to help assist customers in emergency situations.  Almost ALL payday loan companies include in their marketing that their services are meant to be used on a "short-term" basis.  Meaning... emergencies.  But that is not the reality of how payday loans work.

Let's think about this.  In today's economic climate, the majority of Americans are living on a tight budget... paycheck to paycheck, as they say.  I do.  Almost everyone I know has to work to make their money last until their next payday.  A good chunk of the people I know aren't even able to make ends meet... they have a 2-3 day lag where they can't buy anything, because they've spent all their money and don't get paid for a while.  That's the reality of our situation right now.  So it's safe to say that we NEED our paychecks to be as full as possible in order for them to last us to the next one.

Let's say you get paid on Friday, and your check is $700.  You live payday to payday, like I mentioned above, and you usually have a 2 day lag between pay periods where you run out of money.  That means that your $700 paychecks are already too small to cover your needs.

Now, let's say it's Tuesday before your payday and you have a bill that's due now.  You think you're safe to borrow the money from next payday, so you take a loan for $200.  The processing fee for this payday loan is one quarter, so you owe them $50.  When you get paid on Friday, they are going to automatically take a payment of $250 from your paycheck... so now, instead of $700 (which is already too small), you are starting your new pay period with only $450.  How on earth are you going to live for two weeks with only $450?


Well, see, that's what the payday loan companies LOVE to see.  They've already won you over... now, because you took the loan, you can't afford your bills.  So... you need to take another loan.  You call them back and borrow $250... enough to get you back to where you would normally be.  Sounds fair, right?  Sure... but fast forward two weeks when you get paid again and your $700 is now only $387.50.  Not enough to get you though.

It's a snowball... they know your weakness, and they take complete advantage of it, digging you into a hole where you are literally DEPENDENT on payday loans in order to survive.  (In my job, I'm not kidding, I have seen customers who are using 5 payday loan companies simultaneously and have gotten themselves so far behind in the snowball that it would take them over 10 FULL PAYCHECKS just to pay back the amount they owe.  That seems extreme, but it is absolutely the reality of the payday loan world.)

3) Manipulation
I've mentioned it in other blog posts, and you'll hear me talk about it a lot more, as it is one of my biggest banking pet peeves.  It is called ACH (automated clearing house)... it is the electronic payment of a bill from your checking account.  Basically, how it works is like this:  you provide your checking account number to a company and they go in automatically to pay your bill for you.  It is marketed as easy and convenient for you, because you don't have to remember to pay your bills, but it is actually an incredibly dangerous practice that can get you into tons of trouble- especially if you are re-building or developing a strong financial portfolio.  And payday loan companies are notorious.

They don't need your permission... they already have your account number.  Remember... you gave it to them so that they could electronically deposit the money into your account.  In the fine print of the agreement, if not explicitly stated when you take the loan, they will use the same information to electronically TAKE your payment from your account.  This wouldn't be a problem if companies were legitimate and ethical... but, let's face it... most are not.

Here's an important thing to remember: even if you are very diligent about asking the right questions... even if you know for sure what your contract with the company is... that does NOT mean that they will follow through.  Let's say you agree to make two payments of $200 on the 1st of the month and then on the 15th of the month.  Well... the bank doesn't know that.  Your financial institution has no idea what your contract is with the merchant.  So the payday loan company can request, basically, whatever they want... and the bank will not know if it's wrong.  Banks have to assume, because the merchant has your account number and routing number, that you have agreed to the payment they are trying to take.  Your bank absolutely cannot protect your from merchant misbehavior.

So, the company comes through instead and collect the full $400 on the 1st of the month, which you had not budgeted for.  You are now overdrawn in your account and have to file a dispute with your bank... which can take 10-30 days to be resolved.  You may have other bills returned in the meantime, which means more overdraft fees... and potentially, fees from those other merchants as well.  In a worse-case scenario, I've seen a customer whose mortgage payment was returned because of a payday loan situation and her the foreclosure process was started on her home before the situation was resolved.

Is it wrong?  Absolutely.  Will the bank help you?  Yes, they will.  But they have to go through certain legal processes, so it is often not instantaneous.  The only way to prevent this is to avoid the cause all together.

4) Fraud
Ok, I'm a fraud banker, so this kind of thing really irks me... it is the OTHER horrible effect of giving these places your checking account number.  Fraud.  Well, technically, it's not fraud because it is disclosed to you i the difficult-to-find and impossible-to-interpret fine print of the agreement you sign when you take the loan.  But most banks consider it fraud and will investigate it as such because it is so overwhelmingly prominent (and sickening).

Here is a view of the privacy policy of one particular payday loan company.  I will not name the company, but I will tell you that this particular privacy policy is pretty much industry standard, so you could expect similar wording no matter what company you choose...

Click here to see larger image.

Here's what I want you to notice... this privacy policy states that they will share your checking account information with third party merchants.  They call them "affiliates", but they are... basically... other companies who you have not agreed to work with, who you do not even know about, who will now have your personal account information.

And, just like I said before, if a merchant contacts the bank to take a payment from you and they are able to provide your account number... the bank has NO IDEA that you didn't actually do business with this company.

At my job, I frequently see customers who have checks presented on their account... checks that were created electronically, not checks that the customer wrote.  This is a normal practice for these "affiliates"... instead of taking payments electronically, they will create a paper check to collect against your account.  (Hint: Why would they do this? Because they know that banks cannot legally file a dispute against a paper item.  They know that the bank can only file fraud... and they know that the fraud procedures are longer and more intense.  They are hoping that you, as the customer, will choose not to file a claim against them because it will seem like too much work for you.  Then, not only do they get the money they already stole from you... your account stays open, so they can continue to take more money from you.)

Here's the problem:  The microsecond you give your account information to that payday loan company... it's gone.  And your bank has absolutely no idea how many companies may have it.  So, when this happens, the bank's only recourse to protect you is to close your account completely and open a new one.  This, as you can imagine, can be incredibly difficult and time-consuming, depending on how many companies use your account number.  Direct deposit from your employer, social security, etc... all of that has to be changed.  And, to get back the money that was stolen from you (IF the bank is even able to recover it) can take up to 90 days.  So that's 90 days that you don't have your money.  The fraud process also usually consists of paperwork, often times including a police report (which, if you've worked with the police department before, can range from very easy to impossibly difficult to procure).

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There is a lot of work being done to make payday loan companies more accountable and to create more transparency.  But... these companies are very good about staying inside their legal boundaries while still manipulating their customers and stealing their money.  The ONLY way to keep yourself safe is to avoid these companies completely.

If you find yourself in an ACTUAL emergency and you need some money to get you through, check with your financial institution.  Many offer a similar service, if you meet a certain set of qualifications.  The bank's service is usually less expensive (although still very costly) and safer.  It doesn't involve giving out your account number, so you don't have to worry about fraud.  The terms and conditions are usually easier to understand and less likely to be manipulated.  You still absolutely have to worry about falling victim to the snowball effect.  Most banks have limitations on how many advances you can take to help you avoid the snowball... but those limits can sometimes be even worse... if you've become accustomed to using the service and then, all of a sudden, you can't use it anymore... how will you pay your bills?

Ultimately... especially if you're re-building or trying to create a strong financial footing... you NEED to avoid payday loans.  Completely.  Don't even consider them.  That is the only way to be completely safe.