Payday Loans

Gary,
I'm in need of some money and cannot get a loan. I have several payday loans, that I cannot get paid off. I've be trying for several years and I only have enough money to re-new. If I cash out my 401k to pay these loans off I will have plenty of money each month to put back in my 401k plan. Will I still face the extra 20% penalty at tax time? I've learned my lesson and I will never get mixed up with paydays again. I think they should be outlawed.
Michelle

They're also known as cash advance loans, check advance loans, post dated check loans or deferred deposit check loans. The Federal Trade Commission has called them "costly cash". There are over 10,000 payday loan 'stores' operating and it's estimated that they collect over $2 billion a year in fees and interest.

Typically the borrower, in this case Michelle, would write a check for the amount of the loan that she wants plus a fee. The size of the fee is based on how much money she's borrowing. The lender agrees to hold the check for one or two weeks. Typically until Michelle's next payday.

At that time Michelle can come in with cash to 'redeem' the check, she can let the lender deposit the check or she can 'roll-over' the loan until her next paycheck. If Michelle chooses to roll the loan, she'll incur another fee.

Payday lenders have the upper hand in collecting. If Michelle can't redeem the loan or refuses to roll it, she'll be informed that they'll deposit her bad check. If it bounces she'll face criminal charges of intentionally writing bad checks. Not to mention bounced check charges from her bank.

Many payday lenders don't want Michelle to know how much she's paying. A Public Interest Research Groups survey found that only 37% of the lenders quoted an accurate Annual Percentage Rate even though the federal Truth In Lending Act requires it.

Most loans are governed by 'usury' laws. Those laws limit the amount of interest that can be charged on a loan. The PIRG survey of payday lenders found interest rates that ranged from 390% to 871%. The average APR was 474%! The same study showed that in one state 77% of the loans were roll-overs.

Presumably Michelle wouldn't be taking a payday loan if she could have gotten the money somewhere else. She would have paid less interest by using a credit card cash advance or borrowing from friends or family. A cash advance on a credit card would cost Michelle between 35% and 50%.

She's considering taking money from her 401k plan. Any withdrawal will be subject to a 10% penalty and will be added to her taxable income for the year. So she'll probably lose 20% of the withdrawal to the federal government. But that's better than paying 400% APR.

Michelle may have a better choice. Borrowing from her 401k plan would provide the money she needs now and allow her to pay it back through payroll deduction. She should speak with the human resources department to find out the details about a 401k loan. The biggest advantage is that money borrowed is not subject to tax penalties or added to her income for tax purposes unless she doesn't repay it.

Other options that don't involve her 401k should also be considered. If she's eligible for overdraft protection at her bank she may want to sign up. The bank fees would be less expensive.

Payday loan companies have sprung up primarily to serve clients who don't qualify for a credit card. If Michelle is among this group she should check her credit report for errors. Roughly one in four reports contain a significant error. A corrected report might qualify her for a credit card. And cash advance privileges.

If Michelle has other monthly payments, she might be able to have one or more of them either reduced or delayed. A call to the creditor might be all it takes.

Another alternative, if she has other debts, would be to see if credit counseling or debt consolidation would work for her. Either could reduce her regular payments and free up some money to pay off the payday loan.

Finally, Michelle should cut any expenses that aren't absolutely necessary. This is a time for drastic measures.

Michelle is in a tough spot. She needs to get these loans paid off before they force her into bankruptcy. Hopefully one of these tools will help her dig out of debt