Payday Loans Vs. Cash Advance Loans: What To Know And How To Avoid Them
Payday loans or app-based cash advance services let you borrow against the next paycheck to meet financial needs. However, they could be harmful because of the high borrowing cost.
For example, annual percentage rates for short term payday loans are determined through a network of state restrictions. These APRs can often reach three or four figures in some cases. According to Federal Reserve data, the average APR of credit cards for 2020 is 15.09%.
Traditional payday loan usage has been decreasing in recent years. A new breed of app-based Cash-Advance Lenders is filling this void. Consumer advocates worry about people flocking to predatory financial service providers as they see incomes dropping during the COVID-19 Pandemic.
Lauren Saunders associate director of National Consumer Law Center (a non-profit consumer-advocacy agency), says, “People turn towards them because they lack enough money.” She says that an advance or loan will not give you extra money if the hours you work are less. “It just makes next weeks worse. COVID’s situation highlights the weaknesses these programs have.”
These loans are seen as the only way to go in times of financial crisis, despite the risks. Here are some things you should consider before getting a payday or cash advance app. There are also funding options and strategies to help you avoid either.
Cash Advance Services vs. payday loans
Payday loans are similar to cash-advance programs from a consumer perspective. Both services are designed to provide quick cash when you’re in an emergency.
Saunders stated that “the biggest difference is pricing”, noting payday loans’ high annual percentage rate. Not to be overlooked are the fees and voluntary contributions commonly made by earned-wage companies, also known under “tips”.
The long history of payday loans has been controversial in the U.S. Payday loans are legal in most of the states, despite attempts to limit them by regulatory agencies. Some states do not have interest caps.
App-based cash advances services are relatively new. The services are sometimes referred to as paid-wage advances, earned-wage advance, or early-wage. These services are often provided not by traditional payday lenders but fintech startups. Many of the major providers, including Dave, PayActiv, Earnin and PayActiv have emerged in the last ten years.
Earnin and Dave offer earned-wage cash advances that allow users to tip instead of charging loan finance fees. Earnin suggests tipping in dollar amounts of between $14 and $15 per advance. Dave suggests a tip between 5 and 15% of the total advance. PayActiv offers employers a payroll benefit. It makes money through its membership and services fees.
Payday loan services appeal to the economically most vulnerable. According to the Federal Deposit Insurance Corporation’s (FDIC) latest survey data, more Americans than 8.9 millions have used alternative financial services like payday loans over the past 12 months. The majority of these households are lower-income, with more than 8 million using them.
Consumer advocacy groups assert that people turn to payday loans and other payroll advances when they don’t make enough money in the short-term and are looking for help in the future. Instead of aiding, these loans and advances often kickstart what consumer advocates call a dangerous debt trap or “cycle to debt”.
Saunders says that if you run out of money, and borrow against your next salary, you are likely to be short on your next paycheck. It will make it difficult to make it through the next payday without borrowing again.
Earned-wage advances, payday loans, and both payday loans can cause this spiraling effect.
Payday Loans: What to Know
According to data collected nationwide by the Consumer Federation of America (CFA), 31 states allow payday loan lending. Washington, D.C., along with 19 other states, prohibit payday lending in the traditional sense, that is, as a two week, high-interest loan.
The interest-rate caps are not set in all four states, but Missouri is the only state that allows a 1,950% rate of return on $100, 14-day loans.
How can the APR of payday loans get so high. It all depends on the math. APR does not just include percentages, but also factors that are time-dependent. Missouri consumer could be in dire straits and need a 2-week loan to help them get by. They borrow $100 now. The lender will charge a $75 fee for the payday. The interest rate might seem to be 75% at first glance. This is because time isn’t taken into account.
Payday loans’ true costs should be measured in per year rates. An apparently small fee to borrow money could lead to an unfavorable APR due the loan’s length.
Payday loans tend to be targeted at people who need cash quickly and are typically easier to obtain than other financial products. A lot of times, all that is required to obtain a loan approval is a photo ID and proof or income. Lenders frequently approve applicants quickly by skipping credit checks.
Fast cash can sound like a great solution but it can create dependency. Consumer advocates advise them to be used only as an emergency or last resort.
Charla Rios was a Center for Responsible Lending researcher and payday-loan/predatory-debt expert who wrote an email stating that research on payday loans had shown that this product can cause more harm than good.
It’s not something that many people know. So, they are looking for fintech alternatives.
What you should know about cash advance apps and services
Earnin & Dave, two of the most popular apps for cash advances, are seen as alternatives and predatory lenders to payday lenders. However, consumer advocates see them as the “good guys” to payday lenders.
Rios says that the marketing is being used to reach potential borrowers and consumers.
Earnin is one example. It offers advances of up to $500 and $100 respectively. For a payday loan to qualify, users must provide more personal information than for an advance. Earnin allows users to have access to their bank accounts. This allows Earnin to review pay history and other factors.
The app tracks GPS data and determines if a borrower is actually getting to work over the term of an approved advance. Earnin automatically debits the advance amount after payday hits. No interest. No fees.
What does Earnin earn? Voluntary tips between $0 and $14 per advance. But consumers could be confused by the use of the term “voluntary hints”.
For example, tipping might cause you to think about gratuity and etiquette as they relate to the service industry. However, this may be less true when you consider predatory APRs. Tipping your Postmate in exchange for speedy delivery is very different than tipping on cash advances.
Saunders went for a completely different word: voluntary.
Saunders mentions that Earnin had stopped using the practice in the past.
According to the New York Post report, Earnin was limiting advance amounts to New York residents who weren’t tipping as recent as September 2019. The Post reported Earnin quit the practice because of an ongoing probe by the New York Department of Financial Services.
In March 2019, NYDFS launched an investigation to see if Earnin, and similar earned-wage lending institutions, were violating small-loan rates caps. The investigation was expanded to include 10 additional states and Puerto Rico by August 2019.
Critics argue that the tip could outweigh predatory lending caps or violate state regulations.
“A $100 advance made five days before your payday with a $5 ‘tip’ or fee is equivalent to an average annual percentage rate (365%,” National Consumer Law Center wrote March in a report on earned-wage advances.
Rios, Saunders, and others warn that payroll advances can lead just like payday loan debt.
Rios says that accessing future earnings won’t fix the cash shortage issue.
Earnin declined any comment regarding how often its users request advance loans or leave tips. Earnin also declined to compare tips to predatory loan APRs.
How to Avoid Payday loans and Cash Advance Loans
Financial crises can be inevitable. However, you have complete control over your response. It’s clear that payday loans should not be combined with earned-wage advancements. This could result in a long-term debt cycle. The Consumer Financial Protection Bureau recommends a few steps that you should take prior to borrowing from your next paycheck.
- For help, reach out and ask for help from nonprofit organizations, community groups, employers, or friends and families
- By negotiating with your creditor, or debt collector, you can lower your payments
- You can get a credit card with interest rates that are lower than those for traditional payday loans if you have a great credit history.
- Even if your financial situation is not dire, you can start to save money for an emergency fund.
Rios warns against “any promises of quick money or places that do no look at the ability to repay loans.”
Saunders suggests looking into payroll advances and earned-wage options if you have exhausted all options before taking out a loan. PayActiv, which offers payroll services through your company, would be ideal to provide the advance.
She warns that you should not entertain direct-to–consumer versions like Dave, Earnin or Earnin unless your next pay period is larger than usual. This will ensure that you don’t have an income gap when you get your next paycheck.
“If there’s a stimulus check next week and you know you have more money coming in it’s not likely to be a problem for you to take an increase. Saunders clarifies that this is a rare situation.
She notes that the new breed of fintech-based payroll lenders is not harmless and they are for-profit ventures that make money. They are not providing advances out the goodness of their hearts.