The Fine Print Behind “Quick and Easy” Predatory Loans

September 5, 2024
Financial Education

Know Who You’re Borrowing From

At Madison Credit Union, we understand that financial emergencies can arise when you least expect them. In today’s economic climate, many are still recovering from the COVID-19 rebound, grappling with higher inflation and rising costs. Unfortunately, salaries haven’t kept pace with these changes, leading to dwindling savings accounts and a growing reliance on personal loans.

With the convenience of technology, it’s no longer necessary to manage our money in a brick-and-mortar building. We can do everything online, including applying for personal loans or lines of credit. While the idea of taking out a loan online isn’t inherently problematic, it’s crucial to be wary of where the loan is coming from and, more importantly, the interest rates and fees attached to it. This article explores the hidden dangers of high-interest online loans and payday loans, and how these seemingly convenient solutions can quickly spiral into financial hardship.

The Lure of Easy Money

Many recent online lenders and payday lenders often advertise their services as quick fixes for urgent financial needs. Their promises of instant cash and no credit checks may sound appealing, especially in a crisis. However, what they don’t emphasize is the true cost of borrowing from them.

With the ease of access that online lenders provide, it’s tempting to take out a loan without fully understanding the terms. This convenience, however, can come with significant drawbacks. Many online lenders take advantage of the lack of regulation to impose sky-high interest rates, flat fees disguised as low-cost alternatives, and steep loan origination fees that reduce the actual amount you receive.

Installment Loans with Sky-High Interest Rates

Installment loans are loans with a fixed interest rate for a fixed period of time (6-months, 12-months, etc.). Since there is no federal maximum level on interest rates for loans, each state sets its own usury laws. These laws are meant to prevent companies from charging excessively high interest rates, but they vary drastically from state to state. For example, on a $500, 6-month loan, Michigan sets a rate cap at 43% APR, while Mississippi allows up to 305% APR. Wisconsin, on the other hand, does not have a cap, relying on vague guidelines of “unconscionability.”

This lack of regulation allows predatory lenders to thrive. Many of these lenders offer loans that target individuals in desperate financial situations.

A prime example is MoneyKey, which offers online installment loans in states like Wisconsin that have no interest rate caps. With an APR of around 290%, a $550 loan from MoneyKey with a 12-month term would cost the borrower $1,562.83—that’s over $1,000 in interest alone!

Big Flat Fees

Some lenders try to disguise their high interest rates with flat fees, which may seem more appealing at first glance. However, these fees often equate to extremely high APRs.

For example, CreditFresh offers personal lines of credit with a “Billing Cycle Charge” instead of a traditional interest rate. When calculated, this charge can amount to an APR of around 150%, or even higher. A $550 loan would result in $840 in fees over the first year alone, while only reducing the principal by $109.59.

Loan Origination Fees

Other lenders may avoid high interest rates and flat fees by imposing loan origination fees instead. These are one-time payments made to cover the costs of processing a loan application. They are typically deducted from the loan amount before disbursement.

For example, Upstart offers loans with interest rates up to 35.99% APR and origination fees up to 12% of the loan amount. If you borrow $1,000, you might only receive $880 after the origination fee, yet still be required to repay the full $1,000 plus interest over a 3-5 year period.

Payday Loans

The interest rates on payday loans can be shockingly high. The Wisconsin Guide to Payday Loans reported that in 2022, the average interest rate on payday loans was a staggering 863.92% APR (Annual Percentage Rate). Many online fast cash lenders charge similarly high interest rates.

For instance, Check City offers loans from $200 to $3,000 with interest rates ranging from 386.40% to 411.22% APR, depending on whether you set up autopay. A $700 loan could end up costing you as much as $1,735.44, more than doubling the original loan amount in just six months.

The financial burden can quickly become overwhelming, turning a short-term solution into a long-term problem.

The Cycle of Debt

One of the biggest dangers of payday loans is the cycle of debt they can create. The Consumer Financial Protection Bureau (CFPB) reports that more than 80% of payday loans are rolled over or followed by another loan within two weeks. This happens because borrowers often cannot afford to pay off the entire loan by the due date, so they take out another loan to cover the first, accumulating more fees and interest in the process. The CFPB further reports that 20% of payday loans end up in default.

The Impact on Your Credit and Financial Health

While payday lenders and some online lenders may not require a credit check upfront, failing to repay any type of loan can still negatively impact your credit score. If a lender reports your default to the credit bureaus, your credit score can drop significantly, making it harder to obtain affordable credit in the future.

Furthermore, the stress of managing high interest loan debt can take a toll on your overall financial well-being. You may find yourself struggling to pay bills, cover daily expenses, or save for important goals. All these can lead to long-term financial insecurity.

Alternatives to High-Interest Loans

Before turning to a payday or high-interest lender, consider exploring other options:

Credit Unions: Many credit unions offer small-dollar loans with much lower interest rates compared to payday lenders. As a member-focused institution, credit unions are often more willing to work with borrowers to find affordable solutions.
Personal Loans: If you have decent credit, a personal loan from a bank or credit union may offer a lower interest rate and more manageable repayment terms than a payday loan. Even in situations with poor credit, lenders from credit unions will try to work with you.
Payment Plans: If you need a loan to cover a specific expense, such as a medical bill, ask the provider if they offer a payment plan. Many healthcare providers, utility companies, and other service providers are willing to set up interest-free payment plans for those who need them.
Borrowing from Friends or Family: While it may feel uncomfortable, borrowing from a trusted friend or family member can be a safer and more affordable option than a high-interest loan.

Conclusion

While online quick cash loans may seem like an easy solution, the high-interest rates and fees can quickly spiral out of control. Before taking out a high-interest loan, explore the options available through your local credit union or bank. Or speak with a financial advisor on setting a budget and working with

Additional Recourses:

See our follow-up article: Breaking Free: 10 Practical Tips to Escape the Debt Spiral
Balance Pro – all Madison Credit Union members have access to free financial counseling services. Just mention you are a member of Madison Credit Union.
Wisconsin 211 – call or visit them online for assistance on locating help for finances, housing, food, and utilities, and so much more.
GreenPath Financial Assistance for help on consolidating uncontrollable debt and negotiating with creditors.
Madison CU Financial Smarts – visit our Financial Smarts page for helpful budget forms, articles and videos.

Sources:

Consumer Financial Protection Bureau. “What Is a Payday Loan?” CFPB Website.
Federal Reserve. “Report on the Economic Well-Being of U.S. Households in 2022.” Federal Reserve Website.
Consumer Financial Protection Bureau. “CFPB Report Finds Payday Loans Can Trap Borrowers in Debt Cycle.” CFPB Website.