When you are in a bit of a financial bind, it can often be tempting to look for a fast and easy way to get the cash you need. This is especially true between paydays when you have an unexpected expense come up. Just about everyone has had to deal with this at some point.
This article covers everything you need to know about payday loans. Keep reading for more insight on how these types of loans work and why you should avoid them at all costs!
What Are Payday Loans and How Do They Work?
Payday loans are available through certain brick and mortar lenders, as well as online lenders. They can be hard to repay, and they could end up costing far more than you realize.
These loans are small and are usually only for a few hundred dollars. The loans are short-term and will often be paid back in a week or a month.
While this might not seem like a big problem, it’s important to realize that they have incredibly high interest rates. Some even enter into the triple-digit range! This can make them extremely difficult to pay off.
After all, if you have trouble covering an expense this week, how will you have the money to pay off the loan plus interest by next week? These are seen as last resort options for cash, and even then, they are not a good idea.
How Do the Loans Work?
The payday loans work simply enough. To get one of these types of loans, the borrower will need to provide the lender with proof of their income, as well as authorized post-dated checks that coincide with the dates when they receive a direct deposit from their employer.
In some cases, the borrowers will grant the lender electronic access to their bank accounts, so they can withdraw money on the date it is due.
The approval process, provided the borrower has all of the above information, tends to be quick. The money is usually automatically deposited into the borrower’s account so they can use it.
Then, when the payment date arrives, the lender will cash the check or will go into the account to take the money and interest they are owed.
As mentioned, the interest on payday loans is massive. The average interest for payday loans is close to 400%. Some states have enacted caps on the amount that can be charged for interest, but it’s still high and often greater than 30%. But more on the negatives later.
Why Do People Use Payday Loans?
Most people today know that payday loans are considered predatory and unethical. They aren’t something that anyone should seek out and use.
However, the lenders are still in business because people keep going back to them. What is it that causes people to use payday loans in the first place? It’s important to get a sense of why they are used.
What Makes Payday Loans Different?
As mentioned, many people simply don’t have enough money in savings to take care of expenses that pop up, such as vehicle trouble or medical expenses. However, it goes deeper than that.
Payday loans are different from other types of loans. They aren’t dependent on the ability of the borrower to pay back the debt. Instead, they depend on the lender’s ability to collect what they are owed.
With traditional types of borrowing, the lenders will look at the financial viability of the borrower before they offer a loan. Traditional lenders look at your credit history and score before making a decision. They are averse to risk, and this means that not everyone will qualify.
The Dark Side of Payday Loans
Payday lenders don’t care about your credit score. They only care about their ability to collect money that you owe them. People who have poor credit and who do not have access to better loans, credit cards, and other options will often turn to payday loans because they feel they do not have any other choice.
They can get one of the loans if they don’t have a credit history or if they have bad credit. They just need to be employed, have a checking account, and have a valid ID. Unfortunately, using these payday loans can cause some serious problems.
The Negatives of Using Payday Loans
Now that you understand the basics of payday loans, it’s time to dissect all of the things that make them such a problem. There are many reasons to avoid these loans due to the dangers they present.
Here are five reasons why you should never get a payday loan:
1. Payday loans are expensive.
Naturally, the biggest problem that comes from these types of loans is the cost. The fees, which are interest rate charges, vary from state to state.
They are generally between $10 and $30 for each $100 borrowed according to the Consumer Financial Protection Bureau (CFPB). Let’s look at an example using $15 per $100, which is on the low end.
If you were to borrow $400, it would cost you $460 to repay the debt when it’s due, typically in one or two weeks on your payday. While $60 might not seem like much, as it equates to 15%, you have to remember that it’s for a short-term loan. If you were to adjust the fee for a year, it becomes 400%.
There’s a case in Ohio where a single mother living in Cincinnati ended up paying $3,878 on an original loan of $800. The lender was harassing her to pay even more before the Legal Aid Society intervened.
2. Rollovers are a reality.
Still, you might be thinking that if you simply pay off that fee, the 15% in the case above, there’s no harm in getting a payday loan as a last resort. However, the reality of things is different. In many states, it is possible to roll over the loan if they can’t afford to pay it back on their next payday. Payday lending companies rely on this.
In the case of the person who borrows $400 and has a $60 fee can roll the loan over for another two weeks…for an additional $60. This means that you are now paying an added $120 for the loan on top of the $400.
The percentage is now 30% rather than 15%. What happens if they can’t pay again and have to roll it over? The cost continues to increase, and you eventually get to the point where there’s no way to catch up. You are in a worse financial place than you were when you started.
3. You can get caught up in the cycle of payday loans.
You might think that this won’t happen to you. You won’t get to the point where you can’t pay the payday loan on the first payday. However, many people end up caught in a vicious cycle with these loans.
Sure, they pay off the initial loan, but now they find that they’re short $30 or $60, or more, for the next month. They end up going back to get another payday loan to cover their bills.
This is because the borrowers are not using the short-term loans for what they should. They aren’t using them for unexpected expenses, at least not any longer. They’ve gotten to the point where they rely on the loans to make it from one pay period to the next, and they are damaging their finances further with each new payday loan.
If you think it’s only a small number of people that are misusing these types of short-term loans, you would be wrong. According to information from Pew Charitable Trusts, 69% of borrowers are using payday loans as a means to cover recurring expenses that should be in their budget. This includes things like their credit card bills, rent, food, mortgage, or utilities.
They have more expenses than income and they are using payday loans to shore up the holes. Sooner or later, they will get to the point where everything comes crashing down around them.
4. Lenders have access to your bank account.
In some cases, lenders will request electronic access to the borrower’s bank account through ACH, or the Automatic Clearing House. It allows lenders to take money directly from your account, and it’s billed as being an easy way to make sure the payments go through.
They can withdraw money from the account, including fees, late charges, etc. before you have a chance to try to talk with them about other options.
This could end up leaving you short on cash, which means your balance could be negative, which causes problems with your utilities, credit card companies, landlord, and more. You could get costly overdraft fees, and you might end up needing to get another payday loan, ensuring you stay on that cycle.
5. Your credit score may take a hit.
Getting a payday loan and paying it off will not do anything to improve your credit score. However, if you do not pay the loan back successfully and on time, the lenders are likely to report your negative behavior to the credit bureaus. There’s a chance that getting one of these loans could hurt your score severely.
Ultimately, payday lenders are predatory. They know that the people who rely on them may not have other options, and they take advantage of these people. Although there are now laws in place in certain states, the negatives of these types of loans persist.
Alternatives to Payday Loans
Instead of trying to get a payday loan to cover expenses, there are other things you can do that could help instead. While those who would normally rely on payday loans will not likely be able to get traditional loans or credit, there are still things that can be done to help with finances. Here are a few of your options.
Talk with Your Lenders Directly
This is one of the first things you’ll want to do when you are potentially getting close to being late on making payments to creditors.
You can talk with them about setting up a different payment plan with installments. You could ask for an extension. Lenders are often willing to work with you because they would rather you work out some type of arrangement with them rather than you defaulting on your loan.
See If You Can Get an Advance at Work
This might not be possible for everyone in all types of job fields, but it can be worth talking about with your employer. It’s not a loan, but rather an advance on your pay that could help you out in the short term. There are no fees associated with an advance, so you don’t have to worry about paying extra.
Borrow Against Other Assets
If you own your own home or have a 401(k), you could try to borrow against those assets. You can get cash to help with short-term needs without getting involved with payday loans.
Family and Friends
In some cases, you might have some family and friends that can provide you with a small short-term loan that will cover your costs for the expense. It’s not a great feeling asking for help, but it’s better than taking out a payday loan that has high interest rates.
At this point, you should understand why you need to stay as far away as possible from payday loans. They will not do anything for you, but they can seriously harm your finances.
The predatory lenders will continue to operate until more people realize how dangerous they are and stop using them. Don’t contribute to them remaining in business.
Start an emergency fund right now. Put a little in it each payday so you have something available for those inevitable emergencies that happen down the road. Always remember that you have more options than you may think.