The Payroll Advance – and why it is a Bad Idea

This year, I became aware of a lending vehicle that is designed to hook the desperate to a never-ending cycle of debt: The Payroll Advance, also known as a Payday Loan.

It is a line of short-term credit that is open to anyone – no background checks, no credit checks, nothing of the sort. For every $100 borrowed, the borrower agrees to pay the lender somewhere between $10 and $20 in interest, on usually a two-week loan term – until the next payday.

Let’s put this into action, using an unfortunate friend as an example. This friend, we’ll call him Larry (name changed to protect the possibly-innocent), borrowed $2,000 to cover medical bills. His terms were $15 on every $100 borrowed, but he was desperate. At the end of the two-week term, Larry needs to pay back the $2,000, plus $300 in interest. That leaves him short on money to pay his bills, and the monthly $600 (roughly) interest ate up whatever leeway he may have to dig himself out of this hole again. The lender, of course, is happy to extend the loan for another month, to hit the next month’s paycheck. And so it goes. Not for long, mind you, in this case – $600 of interest per month would have left Larry without physical assets in just a few months’ time.

I tried calculating the annual interest rate on this loan using MoneyTime, a small shareware utility that lets you quickly figure out loan terms.  MoneyTime balked, telling me that the Interest Rate calculation was “out of range”. Uh-oh. I tried that the other way around, then, by entering stupidly large interest rate values and seeing what the monthly payment would be, until I hit that $300 payment I knew Larry was on.

The annual interest rate for a Payroll Advance that takes 15 cents on the dollar every two weeks is 390%. That means that if you have to stick with a $2,000 loan for half a year, you’ll have paid $3,900 in interest – and you still owe the original $2,000. Owch.

But wait, I hear you say, he got a really rotten deal. What about the ones that take $10 on $100, or the one that advertises on Google for just $8.75 per $100?

Well, that’d be 260%  and about 228% annual interest rate, respectively.  Expressed in interest paid after half a year, that’s $2,600 and $2,300.  No matter how you slice it, it’s a rotten deal. Credit cards, in comparison, are a rotten way to carry debt, and they take a “mere” 25% (ish). Payroll Advance is just a way to juice you dry, and then squeeze some more – and when there’s nothing more to be had from the husk, why, the lender can go to court, and you can go into bankruptcy proceedings.

The way out can be to talk to your bank, or even to a relative or friend. While lending in the family is always dicey, resources like make it easy to put the agreement on a professional footing. If a regular payment schedule is going to be a concern – as it usually is – add in a custom section about a number of granted grace periods, then have the agreement notarized by your bank – which is often free if you have an account there – and live to see another day.

Truth, no one forces anyone to enter into that kind of deal. Desperation, however, does things to people, and that’s what these lenders thrive on.

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  1. Absolutely. This is actually a fascinating topic, which is explored in great historic detail in the book “Secrets of the Temple” which, despite the title, is not a conspiracy theorist’s handbook, but a very balanced account and history of the Federal Reserve Banks and money in the US in general.
    In short, many state and local usury laws were repealed or weakened in 1979/early 80s, due to rampant inflation. It was actually Carter who – reluctantly – signed bank deregulation into law.
    Reagan, I believe, “ran with it” — still working my way through that book to learn more 🙂

  2. I believe you’re math is wrong. If I’m not mistake 390% of $2,000 would be $7,800. The $3,900 you list would be if the loan was only for $1,000. So, really, the situation is even more extreme than your numbers show!

    I have a friend who was in a terrible cycle of debt for about 2 years because he had used payday loans on multiple occasions. It took him quite a long time to dig his way out of the hole he had dug for himself.

  3. Adam, I can see where I got you confused, which means I also confused other readers. I quote an annual interest rate of 390%, but then give an actual dollars-and-cents example of just half a year, not one year. You are right, the interest accrued after a full year of holding a $2,000 debt would be higher, it’d be the $7,800 you mention.

    I calculated for half a year for a reason: I wanted a number that was starkly, stupidly high, and I wanted a shorter period of time than a year, as these loans are usually taken out with a hopeful – if futile – thought of “I’ll just need this for now and I’ll pay it off quickly”. What I wanted to demonstrate is that paying off quickly is nigh impossible without outside help, as your unfortunate friend found out.

    Of course, it might have helped if I had stated my intent explicitly, instead of letting details like “annual interest rate” and “after 6 months” doing the talking for me. Thank you for the comment, and I hope I could clarify the math.

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