By Tim Devaney - 03/25/14 06:00 AM EDT
A consumer watchdog is warning that payday loans can trap borrowers in "spider webs of debt" that are difficult to escape.
In a study released Tuesday, the Consumer Financial Protection Bureau (CFPB) found that four out of five borrowers renew their payday loan within two weeks, because they need more money to pay their bills and makes ends meet.
"Renewing loans repeatedly can put consumers on a slippery slope toward a debt trap where they cannot get ahead of the money they owe," Cordray said.
The CFPB examined more than 12 million payday loans over a period of one year as part of the study.
Payday loans, generally small loans of $500 or less, help borrowers meet their most immediate financial needs from rent payments to medical bills to car emergencies, but in many cases they leave consumers worse off in the long term, Cordray argued.
The payments usually come out of the borrower's next paycheck just two weeks down the road with a hefty fee of 15 percent -- which when calculated on an annual basis is nearly 400 percent, according to the CFPB.
Because the payments are due so quickly, many borrowers do not enough time to get the money together and have to rollover the loan, paying even more in interest and fees, Corday said.
The study found that one in five borrowers end up paying more in fees and interest than the amount they borrowed.
"For consumers in a pinch, getting the cash they need can seem worth it at any cost," Cordray said. "Many consumers would never dream of paying an annual percentage rate of 400 percent on a credit card or any other type of loan, but they might do it for a payday loan where it feels like they can get in and out of the loan very quickly."
But only 15 percent of borrowers repay the entire payday loan in time without taking out more money to pay for the first loan. Meanwhile, 20 percent of borrowers default on the loan at some point.
These borrowers typically can't get credit elsewhere, so they turn to payday loans. About 12 million Americans use payday loans.
Cordray indicated he would take a hardline on payday lenders, saying the CFPB was working on reforms.
While he recognized that payday loans provide much-needed access to short-term cash, he also said that many of the risky lenders "have no place" in the business.
Cordray said the CFPB is also concerned about reports of a "troubling number" of payday lenders harassing borrowers through "false threats, disclosing debts to third parties, making repeated phone calls, and continuing to call borrowers after being requested to stop."
The CFPB began regulating payday loans in January 2012, but it looking to establish a new set of reforms. The agency has already taken action against payday lenders, such as Cash America International and CashCall, which is accused of collected money that consumers did not owe.
"The fundamental problem is that too many borrowers cannot afford the debt they are taking on, or at least cannot afford the size of the payments required by a payday loan," Cordray said.
"In the end, consumers are at risk of using these products in ways that go beyond their intended purpose," he added.