What To Know And How To Avoid Them – Forbes AdvisorJuly 8, 2020
Payday loans and app-based cash advance services allow you to borrow against your next paycheck to meet your financial needs today. But because of their high borrowing costs, these services could do more harm than good.
Annual percentage rates for short-term payday loans, for example, are determined by a patchwork of state-level restrictions, and payday loan APRs frequently reach three figures—in some cases, four figures. By comparison, the average APR for credit cards so far in 2020 is 15.09%, according to the Federal Reserve.
In recent years, traditional payday loan usage has been on the decline, but a new breed of app-based cash-advance lenders is filling the void. With incomes down during the COVID-19 pandemic, consumer advocates worry that people might flock to predatory financial services.
“People turn to them because they don’t have enough money,” says Lauren Saunders, the associate director of the National Consumer Law Center, a nonprofit consumer-advocacy organization. But if you’re working fewer hours, an advance or a loan doesn’t give you any extra money, she says. “It just makes next week worse. The COVID situation really highlights the weaknesses of these programs.”
Despite the risks, some consumers see them as the only option in tough financial situations. Here’s everything to consider before taking out a payday loan or using a cash advance app—plus funding alternatives and financial strategies to help you avoid both of them.
Payday Loans Vs. Cash Advance Services
From a consumer’s perspective, payday loans and cash-advance services share more similarities than differences. Both services promise quick cash when you’re in a bind by providing the opportunity to borrow money you can repay from your next paycheck.
“The biggest difference is pricing,” Saunders says, noting that payday loans are notorious for high annual percentage rates. But the fees and voluntary payments commonly charged by earned-wage services, also known as “tips,” shouldn’t be ignored.
Traditional payday loans have a long and controversial history in the U.S. Over the years, lawmakers have tightened and loosened restrictions on lenders by enacting regulations that specify allowable loan term lengths and maximum financing fees. Despite regulatory efforts to limit them, payday loans are still legal in most states. And some states have no explicit interest caps at all.
App-based cash advance services, however, are a relatively new concept. The services are also referred to as earned-wage, early-wage or payroll advances, which are often provided by fintech startups, not traditional payday lenders. Most major providers, including Earnin, PayActiv and Dave, have sprouted up within the last decade.
Instead of charging loan financing fees, earned-wage advance services like Earnin and Dave prompt users to tip on their “free” cash advance. Earnin suggests tips in dollar amounts, up to $14 per advance,…