The Lowdown on Payday Loans

The idea of seriously limiting payday loans seems to be gaining momentum. Katherine Mangu-Ward takes an in-depth look at the ramifications of such a move here.

Why do people here and elsewhere seek short-term, high-interest loans, using a chunk of their next paycheck as collateral? Well, what would you do if you needed $200 RIGHT NOW?

You could put it on your credit card. It’s the American way! Unless, like so many Americans, you’ve already maxed out your cards. The average U.S. consumer carries $6,226 in plastic debt, according to the credit reporting agency TransUnion. With a potentially long financial market contraction ahead, card companies have been aggressively reducing limits and discontinuing new offers. Although the Credit Card Act of 2009 makes it harder for companies to change their terms after the fact, the availability of credit is likely to shrink further. Maybe you need that $200 to make the minimum payments on those maxed-out cards.

You could write a personal check and hope to scrounge some money for your bank account in time to cover the transaction. Such faith has a low rate of return, and dashed hopes can be awfully expensive. A bounced check from a basic Bank of America checking account, for example, costs $35, plus any fees the stiffed merchant tacks on. Many banks offer overdraft protection-they’ll extract the money from you later-but charge between $10 and $35 for the favor. Repeated bounces and overdrafts have more serious consequences. American banks unilaterally closed 6.4 million checking accounts in the pre-recession year of 2005 alone.

You could borrow money from friends or relatives. Obtaining cash from intimates may get you the best interest rate on the market, but costs are extracted through other means. Family reunions can easily become awkward investors’ meetings, and as fans of Judge Judy can tell you, even a small loan can be a remarkably efficient way to destroy a friendship.

You could pay a bill late. A high-risk strategy. Utility and phone providers can be quick to cut off service and charge a disconnect and/or reconnect fee. You could be looking at an extra $40 to $70 penalty every time, not to mention costs incurred in lost productivity.

Or you could get a payday loan. Like I did.