Many of you are working hard to establish financial stability for you and your family. As you do so, it’s important to be aware of and able to avoid one the most common financial pitfalls – high-cost, short-term loans.

As an advocate for fair lending, I’ve seen abusive lending practices trap households in a cycle of debt. CFA surveys find that the fee for a typical two-week $400 payday loan is $60, which calculates to an outrageous annual interest rate of 390%. On top of that, the average borrower extends the loan eight times, in the end paying an average of $540 in fees plus the original loan amount of $400.

Fifteen states and the District of Columbia have effectively outlawed ‘predatory’ payday lending by capping annual interest rates for lenders or banning the product, but until we’ve made this type of lending illegal across the country, do your part by watching out for and avoiding these loans.

In general, you want to avoid any short-term loans that cost more than a few dollars for every $100 you borrow. Additionally, beware of getting loans based on a valuable family asset, such as your next paycheck, your bank account, your car title, or tax credits you have coming from the IRS.

• Payday loans.  These quick cash loans involve writing a check for the amount of the loan and the finance charge that the payday lender holds until your next payday when the full amount must be repaid. Failure to pay results in a bounced check, extra fees, and, sometimes, a closed bank account. Industry analysts claim consumers pay $8.6 billion in fees to store and online payday lenders per year.
• Refund Anticipation Loans (RALs): RALs are bank loans secured by the taxpayer’s expected refund – loans that last about 8-15 days until the actual IRS refund repays the loan. That short time frame is a good indication of just how needless most RALs are; most taxpayers could have their refund in two weeks or less even without the costly loan. Over 8.67 million American taxpayers received a RAL in 2007, costing them $833 million in loan fees.
• Car title loans: Consumers who own their vehicles get one-month loans secured by the title to the car. CFA surveys find that an average title loan costs 300% annual interest. The typical borrower renews a title loan seven times a year, with about one in five cars lost to repossession annually. Title lending is legal in less than half the states.

There are several alternatives to these types of short-term, high-cost loans.

• Establish a savings account for emergencies. Having at least a few hundred dollars saved – or even, in an ideal scenario, three to six months worth of income – will go a long way toward helping you avoid high-cost loans.
• Keep a credit card on hand for emergencies or when you might otherwise need a loan. Even a credit card at 15-25% annual interest rate is preferable to a loan at a 300-400% annual interest rate. As always when using credit cards, pay off your balance as quickly as possible and be careful to avoid late fees and other charges by paying your bill on time.
• To get fast tax refunds, prepare your tax return right away, file electronically, and tell the IRS to direct deposit your refund into your own bank account. You will get fast access to your tax refund without paying triple digit interest to borrow from a bank.
• For more information on avoiding high cost, high-risk small loans, go to CFA’s consumer information website here and click on Consumer Help. The Americans for Fairness in Lending website is good place to learn more about efforts to curb abusive lending.

I hope this information helps you avoid short-term, high-cost loans, and keeps your household on track to building wealth, not debt.