When you’re low on cash between paychecks or have an unexpected financial emergency, a payday loan can be a tempting option to help you make ends meet or access cash quickly. However, these short-term loans, which are usually due on the day of your next payday, are extremely risky. They come with very high interest rates and other charges. The interest rate on payday loans in the United States ranges from 154% to 664% or more.
Equally troubling, payday loans are often marketed to those who can least afford them, i.e. people who earn less than $40,000 a year. Although this type of loan is marketed as a short-term loan, payday loans can create a cycle of debt that is difficult to break free from.
What is a personal loan?
A payday loan is usually a short-term loan, lasting two to four weeks, that does not require collateral to be obtained. These types of loans are generally supposed to be repaid in a single payment with your next paycheck, when you receive Social Security income, or when you receive a pension payment.
In the majority of cases, payday loans are granted for relatively small amounts, often $500 or less, with the average borrower getting a payday loan of around $375. In some cases, payday loans can be made for larger amounts.
To obtain a payday loan, borrowers are asked to write a personal check for the amount of debt plus finance charges and fees. If the loan is not repaid on time, the lender will deposit the check to recover their funds. Some lenders may request authorization to electronically deduct the funds from your bank account instead of requiring you to provide a personal check.
Payday loans generally do not involve credit checks, and your ability to repay debt while continuing to pay your daily expenses is generally not considered part of the application process.
Who usually takes out a personal loan?
Payday loans are most often sought out by those with ongoing cash flow issues, as opposed to borrowers who find themselves facing a financial emergency. A study of payday loans conducted by Pew Charitable Trusts found that the vast majority of payday loan users, 69%, first took out this type of loan to cover recurring expenses such as utility bills. utilities, rent, mortgages, student loan payments or credit cards. bills. Only 16% of borrowers use payday loans for unexpected expenses.
These types of loans are also widely used by people living in neighborhoods and communities that are underserved by traditional banks or by those who do not have a bank account with a major financial institution. There are approximately 23,000 payday lenders across the country, many of which are located in storefronts or operate online.
What are the risks of personal loans?
Due to the many risks associated with payday loans, they are often considered predatory loans.
For starters, payday loans often come with astronomical interest rates. Those who take out such loans have to pay between $10 and $30 for every $100 borrowed. A typical payday loan with a two-week repayment term and a fee of $15 per $100 equates to an APR of nearly 400%.
Many payday lenders also offer rollovers or renewals, which allow you to simply pay the cost of borrowing the money on the loan’s due date and extend the balance owing for a longer period. It can be a slippery slope that has borrowers quickly getting in over their heads with accrued fees and interest. According to the Consumer Financial Protection Bureau, borrowers default on up to one in five payday loans.
Further, since payday loans do not consider the full financial situation of the applicant, including their ability to meet other financial obligations and living expenses while repaying the payday loan, this type of loan often leaves borrowers in a vicious cycle of debt.
Are payday loans really worth it?
With their high interest rates and fees, a payday loan is rarely a good idea. The fees alone cost Americans $4 billion a year. Because the costs associated with these loans are so high, borrowers often struggle to repay them and take on more debt, so it’s a good idea to carefully consider your options before taking out a payday loan.
However, if you are in dire need or need cash quickly and you are absolutely certain that you can repay the loan with your next paycheck, a payday loan may be a good idea. These loans may also be worth considering if you have no other financial options or have poor credit and would not qualify for a traditional loan.
Alternatives to payday loans
Before taking on the significant financial risks associated with a payday loan, consider other alternatives that may be less expensive. Some of the options to consider include:
- Personal loan: For those with good credit, a personal loan can be a safer and more cost-effective borrowing option. Plus, if you need cash fast, there are online lenders who can provide personal loan funds in as little as a day or two.
- Borrowing money from family or friends: Payday loans should be a last resort. If you have family or friends who are willing to help you, it may be better to borrow money from loved ones than from a predatory lender.
- Home Equity Loan: Tapping into the equity in your home will give you a much more competitive interest rate than a payday loan. Home equity loans are a popular way to access cash to consolidate debt or pay for other large or unexpected expenses. However, to access the equity in your home, you will need to meet certain requirements, including having a good credit rating, a stable income, and a debt-to-equity ratio of 43% or less.