Reloadable prepaid cards address the financial needs of some consumers, and usage is more common among unbanked households, especially in lower-income households, less-educated households, younger households, and some minority households (Figure). 12 Unbanked borrowers, as the word implies, do not have a traditional bank or credit union account at all. Underbanked consumers have a bank account but also use alternative financial services, such as payday loans. When using a prepaid debit card, the amount of the loan is deposited directly on the card and the borrower gives the lender the right to electronically deduct the full amount from their prepaid card when the payment is due.
Practices within states are determined by regulations that address concerns such as repeat borrowing, cooling-off (waiting) periods between loans, loan limits, loan lengths, renewal restrictions, and effective APR caps
The cost of a payday loan is problematic. Collectively, borrowers spend as much as $9 billion each year on payday loan fees. On average, the fee for a payday loan is $55 for a two-week loan, and the typical $375 loan will incur $520 in fees because of repeat borrowing. 13 But the federal Truth in Lending Act arms borrowers with valuable knowledge and facts about the cost of borrowing. The law requires the lender to disclose the cost of a payday loan before a borrower enters into a loan agreement. The fee-based structure of payday lending is quite different from a traditional loan, and, comparatively, payday loans cost far more than traditional loans. Lenders must disclose the cost both in terms of the finance charge (fee) and also as an annual percentage rate (APR). 14 From this information, consumers can compare the cost of a payday loan with other types of borrowing. To calculate the ount borrowed are compared with what the amount would be for a one-year period (see “Calculating the APR of a Payday Loan”).
As many as 12 million Americans use payday loans each year. 15 Payday loans are marketed as helpful for unexpected or emergency expenses. However, 7 of 10 borrowers use the loans for basic expenses such as rent and utilities. This comes as no surprise since as many as 58 percent of borrowers have difficulty meeting basic monthly expenses. 16
Payday lenders choose to locate their storefronts in areas where they market to specific segments of the population. Also, on average, payday loan borrowers have low education levels. 17
For example, payday storefronts are more likely to be concentrated in locations with higher-than-average poverty rates, lower income levels, more single parents, and with some minority groups
Payday loans fulfill a need for many people, especially consumers who don’t have access to traditional loans or who have no or low credit scores. 18 In 2017, estimates show that among U.S. households, 6.5 percent (8.4 million) were unbanked; and 18.7 percent (24.2 million) were underbanked-that is, they had a bank account but used alternative financial services, such as payday loans. 19 With bad credit (no or low credit scores), these consumers are often unable to get traditional loans, so they turn to alternative lenders.
Historically, payday lending has been regulated by individual state law; each state has its own specific regulations. It gets complicated trying to understand payday lending with so many differences. Seventeen states and the District of Columbia either prohibit payday lending entirely or have set interest rate caps that force lenders out of business because of unprofitability. 20 The remaining 33 states permit payday lending. These states have either exempted payday loans payday loans Illinois from usury laws or chosen to not regulate the interest rates on the loans. 21
22 To add to the complexity, some states require payday loans to have installment payments rather than the traditional single balloon payment. 23 The many combinations of regulations within individual states mean payday loans are structured and priced very differently. Among states that permit payday lending, there is a wide variation in the cost of borrowing. Within a given state, lenders charge similar fees that are set at or near the maximum allowed by law (see “Sample of U.S. Payday Loan Interest Rates Calculated for a Typical Payday Loan”).