When people come in for their first meeting with me, I ask lots of questions. One of those questions is how they’ve been making ends meet. For many, they’ve stopped paying their bills. Others have gotten help from family members. But more often than not, people tell me that they have resorted to payday loans.
Wikipedia defines payday loans as
a small, short-term, loan secured against a customer’s next pay check. The loans are also sometimes referred to as cash advances, though that term can also refer to cash provided against a prearranged line of credit such as a credit card. Pay day advance loans rely on the consumer having previous payroll and employment records. Legislation regarding payday loans varies widely between different countries and, within the USA, between different states.
To prevent usury (unreasonable and excessive rates of interest), some jurisdictions limit the annual percentage rate (APR) that any lender, including payday lenders, can charge. Some jurisdictions outlaw payday lending entirely, and some have very few restrictions on payday lenders. Due to the extremely short-term nature of payday loans, the difference between nominal APR and effective APR (EAR) can be substantial, because EAR takes compounding into account. For a $15 charge on a $100 2-week payday loan, the annual percentage rate is 26 × 15% = 390%; the usefulness of an annual rate (such as an APR) has been debated because APRs are designed to enable consumers to compare the cost of long-term credit and may not be meaningful in cases where the loan will be outstanding for only a few weeks. Likewise, an “effective” rate (such as an EAR — (1.15 − 1) × 100% = 3,685%) may have even more limited value because payday loans do not permit interest compounding; the principal amount remains the same, regardless of how long the loan is outstanding. Nevertheless, careful scrutiny of the particular measure of loan cost quoted is necessary to make meaningful comparisons.
As you can imagine, relying on these loans to make ends meet can easily and quickly put a person farther in debt. Making ends meet becomes impossible, and that’s when bankruptcy looks more and more like the only option available.
The issue isn’t whether bankruptcy will eliminate these payday loans. It will. The issue is when a person should file bankruptcy if they’ve taken out a payday loan.
Since payday loans could be considered cash advances, we have to look at Section 523(a)(2)(C)(i)(II) of the Bankruptcy Code. This Section states that “cash advances aggregating more than $875 that are extensions of consumer credit under an open end credit plan obtained by an individual debtor on or within 70 days before the order for relief under this title, are presumed to be nondischargeable.”
What this means is that if you’ve borrowed from a single creditor more than $875 in the 70 days before you file bankruptcy, the lender could argue that this debt can’t be eliminated. While the lender may decide it’s not worthwhile to pursue smaller claims, it can be hard to predict how diligent a creditor will be. The better course would be to wait until 71 days from the date of your last payday loan to file bankruptcy and cut off any Section 523 argument your creditors might have.
In bankruptcy, timing is everything. File too soon, and you might run into trouble with creditors. You might even lose out on having debts discharged if you had waited longer. Of course, if you wait too long, you might run into other trouble, like having your paycheck garnished.