This Type of Loan Is So Predatory, Some States Have Banned Them. Here's Why

When a lender imposes unfair loan terms on a borrower, it's considered predatory lending. And there's no doubt that payday lenders impose some of the most unfair loan terms on low-income borrowers legally permissible in their state. Fortunately, 19 states have outlawed predatory lending. Unfortunately, residents of 31 other states must learn to recognize predatory lending practices and come up with alternative ways to find the money they need.

If you live in any of these states, predatory lending is illegal: 

• Arizona
• Arkansas
• Colorado
• Connecticut
• Georgia
• Maryland
• Massachusetts
• Montana
• Nebraska
• New Hampshire
• New Jersey
• New Mexico
• New York
• North Carolina
• Pennsylvania
• South Dakota
• Vermont
• West Virginia
• District of Columbia

Shockingly high rates on payday loans

Of the 31 remaining states, five have set a rate cap limit of 36%. Ohio limits the rate payday lenders can charge to 28%. Still, rates are shockingly high. For example:

In Alabama, rates are capped at 456.25%. 

In Alaska, consumers can't pay more than 520%.

In Hawaii, the rate cap is 459%.

In Kentucky, consumers may get caught up in rates as high as 782%.

In Missouri, payday lenders can charge up to 1,955% on a 14-day loan. 

Worse yet, perhaps, there is no limit on the interest rate consumers in Delaware, Idaho, Nevada, Texas, Utah, or Wisconsin may pay. 

Difficult to escape, by design

When you're desperate for money, payday lenders seem like an easy way to meet a need. All most payday lenders require you to provide is: 

• An active bank, credit union, or prepaid card account
• Proof or verification of income
• Valid identification

Payday loans are meant to be short term. In theory, you're supposed to pay the loan back when your next paycheck comes in -- normally in one or two weeks. However, by the time the lender adds fees and interest to the loan, the average borrower can't pay it back and must take out a new loan to cover the old loan. Once that happens, they're forced to deal with a new set of fees and more interest. 

According to the Consumer Financial Protection Bureau (CFPB), 80% of payday loans are not paid back by the date they're due, causing the interest rate to soar and making the loan difficult to pay off. The Pew Charitable Trusts found that the average borrower requires five months to repay a $300 payday loan.  

The "ideal" payday loan borrower

Payday lenders depend on borrowers with credit scores too low to borrow from a reputable lending institution. They justify their interest rates by pointing out that their clientele is "high-risk." And yet, that's who they advertise to and who they hope will walk through the door or log onto their site. The longer it takes a borrower to repay a loan, the more money the lender makes. 

What happens if you don't pay?

If you fail to pay your loan, the payday lender will cash the check you left with it as part of the lending agreement. If there's not enough money in your account, you'll be charged a fee by both your bank and payday lender. Some payday lenders may try to cash the check several times. Each time it bounces, you're charged an overdraft fee. 

If the payday lender can't get the money from your account and you don't roll the original loan over into a new, larger loan, it will likely send the debt to a collection agency. You'll probably owe collections fees, and if the collection agency sues you, you may also owe court costs. 

Tip: If you're not going to be able to repay a payday loan in full by the date it's due, let the lender know. There are steps you can take to get out of payday loan debt. 

Explore other options

Before borrowing funds from a payday lender, take a look at your other options. For example: 

• If you're a member of a credit union or have been with the same bank long enough, you may qualify for a short-term loan, even with poor credit. Check with your financial institution first. 
• If you don't need much money, ask a friend or family member if you can borrow from them. If they agree, put a loan agreement in writing so there's no confusion as to when you'll repay the money. 
• Contact a local nonprofit that helps individuals with short-term financial issues. For example, if you can't afford groceries, reach out to a local food pantry. 
• Take a cash advance from your credit card. Yes, the interest rate will be high, but not as high as you are likely to pay through a payday lender. 

Tip: Don't forget that cash advances on your credit card carry a higher interest rate than everyday purchases. Check with your credit card company to learn what your rate would be. 

The good news is that some states are working to end predatory lending practices. The bad news is that it's a slow process. In the meantime, plan ahead. If possible, build a small emergency fund that you can tap when a problem arises. Even if you can only put a few dollars away a month, it will eventually add up. The only way to beat payday lenders is to never play their game.