Why do Students in the USA Use Loans with Annual Interest Rates of 400%?
Payday loans are becoming a serious problem in the USA. According to a survey by the Center for Responsible Lending (CRL), a US non-profit research agency related to loans, the average annual interest rate (APR) for American payday loans is extremely high at 391%. Despite this, the shocking survey results showed that “1 in 3 college students consider using payday loans”.
The country’s payday loan market has swelled to $9 billion, and the APR in Texas has reached 662%. What are the factors driving young people to take out these super-high interest loans?
What are payday loans?
As the name ”payday loan” suggests, consumers are able to receive small, short-term loans with their pay as collateral. The appeal is that one is able to quickly borrow money more easily than with a regular loan. But because the interest is extremely high and the repayment period is short, unless one has a very strict repayment plan, there is the risk that the debt will grow unmanageable very quickly.
CRL says payday loans companies strategically target low-income groups, but because they recover repayment amounts from the borrower’s next salary, the risk of irrecoverable debts is low. Even if one is a consumer judged to have low repayment ability with poor credit scores, or a student or young person with no repayment history, one is able to borrow with comparative ease. Consumers who have been refused loans by other companies sign up because “even if the interest is high, I can borrow immediately”. Their hand is forced as they have nowhere else to turn and could go on to fall into repayment hell.
Big differences in average APR by state – Texas’s is more than 4 times of Oregon’s
When CRL investigated the average APR offered by major payday loan companies for $300 loans, the 2017 average APR for the whole of the USA was 391%. However, big differences in figures emerge by state. It rises above the average drastically to 662% in Texas, 652% in Nevada, and 602% in Virginia and falls below it at 154% in Oregon, 175% in New Mexico and 214% in Colorado.
With the average APR of credit cards being around 16% (CreditCards.com August 2018 data), the difference is evident.
There is a small percentage of states where upper limits for interest have been established, including Arizona and Montana. But even where there is an upper limit, it is much higher than credit cards at 36%. In many states, consumers are suffering, unable to break out of their payday loan hell.
There are 23,000 companies offering payday loans in the whole of the USA, this is almost twice the number of McDonald’s stores (CNBC article dated 1st August 2018).
The government’s student loans alone are insufficient
In the survey carried out by CNBC of about 3,700 adults interested in payday loans, the ones who showed the strongest interest were Millennials (22-37-year-olds), 51% answered that they “are seriously considering using payday loans”.
However, the results showed that even within Generation Z (18-21-year-olds), which is supposed to consist of students or working adults, 38% are seriously considering using payday loans, 11% “are considering using payday loans in order to compensate for expenses associated with college”, and 5% “have had the experience of actually using payday loans in the past 2 years”.
A key reason why payday loans are appealing to the younger generations, as cited by experts, is a deficit in student loans.
According to an article on the student loan information website studentloanhero.com dated 25th June 2018, the upper limit of student loans financed by the government is $12,500 per year, but this amount would cover all of a student’s tuition fees in only 1.55% of the colleges in the USA. The tuition fees of most colleges exceed the government loan’s upper limit by more than $11,000.
Debts of $500 become $1000 in just 3 months
As a result, many students cannot help but borrow from private loan companies on top of borrowing the government’s student loan. Even so, when the need to search for a source of income arises, finding oneself unable to deal with living expenses or unexpected costs, if one has already received multiple loans, it is difficult to pass the examinations by ordinary loan companies.
This is why increasingly students turn to payday loans, which will be readily offered, even to students. However, if one borrows $500 at an average interest rate of 391% and a 2-week full payment schedule, one must prepare $575 after two weeks. If 3 months pass without one being able to pay in full, it will balloon to $1000 dollars. Later, it will snowball more.
A 21-year-old student who responded to a CNBC interview said that he “is thinking about using payday loans for just 2 weeks”. The reason being, his student loan was two weeks late and he needed the money to pay rent and bills. He places the emphasis on repaying within two weeks, but is this realistic? Unexpected situations, such the repayment being delayed, sudden expenses piling up, may occur. There would be many debtors who would end up succumbing to the temptation of thinking “if it is all right not to return it immediately, let me borrow and keep a little more”.
Almost 1 in 4 users have re-borrowed 9 times or more
Nick Bourke, director of the consumer finance department at independent non-profit organization The Pew Charitable Trusts, has pointed out in a CNBC interview that “only after being able to fully immerse consumers, are payday loans companies established as a business.” Consumers finding themselves fully immersed in repeated payday loans is “the natural course”.
According to Bourke, there is no profitability for the company until the borrower renews the loan agreement or re-borrows 4-8 times. From a Consumer Financial Protection Bureau survey, it is known that almost 1 in 4 payday loan users have re-borrowed 9 times or more.
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