Why are Payday Loans so Controversial?

Payday loans have become controversial due to their potential for borrowers to become trapped in a debt cycle. Learn why payday loans are so controversial and how they can be avoided.

Why are Payday Loans so Controversial?

Payday loans are a source of controversy due to the potential for borrowers to become trapped in a debt cycle. Activists against payday loan firms point out how loans can add up quickly and that lenders may not be doing proper affordability checks before granting loans. Not all lenders cooperate with debt charities, costs are not always transparent, and some lenders may be encouraging consumers to borrow more. According to statistics, those who take out this type of loan often consider it multiple times a year.

Although many people assume that payday lenders charge high interest because they deal with high-risk customers, default rates are usually quite low. In February, the power to suspend a lender's license was granted if consumer harm was suspected. In states where payday loans are severely restricted, there is much less use of payday loans and borrowers are not forced to apply for them online or from other sources. The lender will require a post-dated check to cover the loan plus the fee and cash it at the end of the loan period, usually two weeks.

Payday lenders offer cash advance loans, check advance loans, post-dated check loans or direct deposit loans. Customers can easily get caught in a debt cycle by applying for additional payday loans to pay off old ones. Many customers who use payday loans are unaware of high interest rates and focus more on so-called commissions. Even if your credit wasn't good before the payday loan default, a new collection action is almost certain to make it worse.

This is a special type of loan that is considered an emergency loan when you need to buy something the last few days before your payday. Consumer advocates have long criticized payday loans as debt traps because borrowers are often unable to repay the loan immediately and are stuck in a loan cycle. The charity Citizens Advice reported that in nine out of 10 cases the borrower was not asked to provide documents showing that he could repay the loan. Potentially more worrying is twenty percent of new payday loans that are extended six times (three months), so the borrower ends up paying more in fees than the original principal.

Customers can use payday loans to cover emergencies, such as doctor visits or car problems, but most use the loans to cover utilities, rent, or other recurring monthly bills.

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