When you need to get cash quickly, you might consider turning to payday loans as a source of short-term funding. Payday loans are easy to obtain and do not require any type of credit check, making them more accessible than a personal loan or even a credit card cash advance. But is it really a good idea?
How Payday Loans Work
A payday loan is essentially an advance on your next paycheck. You provide the lender with your pay stub as proof of income and tell them how much you would like to borrow. They give you a loan in that amount, which you’re expected to pay back when you receive your paycheck, along with the lender’s fees for payday loans.
The repayment period depends on how often you receive your paychecks, whether weekly, bi-weekly, or monthly. In addition to proof of employment and a pay stub, you will also need a bank statement or your banking information to apply. Payday loans are typically deposited directly into your bank account once approved, giving you instant access to funds.
Depending on how the lender processes their loans, you may need to write a post-dated check for the loan amount plus any fees. In this case, you may also be required to sign an agreement stating that the check will be held by the lender until the agreed-upon repayment date.
On the due date of the loan, you must repay the loan, plus any fees charged by the lender for payday loans. If you are unable to repay the loan in full, you can request an extension from the lender or roll it over into a new loan, which usually means paying additional fees.
If you default on a payday loan, the potential consequences are similar to defaulting on a credit card or another unsecured debt. Failure to repay may lead the lender to threaten you with criminal proceedings or check fraud. Additionally, you could suffer damage to your credit score if the debt is sent to a collection agency.
The Downsides of Easy Money: Why Payday Loans are Risky
Payday loans are convenient, but that convenience comes at a cost. Finance charges can range from 15% to 30% of the amount borrowed, which can make the annual percentage rate (APR) on the loan skyrocket into the triple digits.
Even if you have the loan for only a few weeks, you are likely to pay a significantly higher amount in interest with a payday loan compared to a personal loan or even a credit card cash advance. Payday loans often become a problem for individuals who use them because they are favored by borrowers who may not have cash or readily available financing options.
One of the biggest risks that come with payday loans is that the borrower falls into a cycle of repeatedly extending the loan. They find themselves unable to repay the loan on payday, so they extend the loan for another pay period. They continue to spend the borrowed funds while fees keep accruing. It’s a vicious cycle that can continue indefinitely since there is no limit to how many times a person can take out this type of loan.
Avoiding the Need for a Loan by Budgeting
The best thing you can do to avoid relying on payday loans is to create a budget to cover your expenses. Cut back on as many unnecessary expenses as you can and focus on adding money to your emergency fund that you can draw upon when cash is tight. Even spare change you find around the house can be set aside in savings and grow interest over time.
Building…
Saving takes time, however, if an unexpected expense arises, there are alternative ways to handle it instead of payday loans. For instance, you may be able to cut out the middleman simply by asking your employer for an advance against your salary. Your employer might offer this in emergencies, without imposing the fees associated with payday loans. But this is not something you want to do frequently.
Alternatives to Payday Loans
You should understand that there are other loan options available to you – known as payday alternative loans (PALs) – even if you have bad credit. These alternative funding methods include online sources and those within your local community. Payday loans should be your last resort.
You can also consider a pawn shop loan. If you have jewelry, tools, electronics, or other valuable items, you can use them as collateral for a short-term loan from a pawn shop. You get cash for your item and can still come back to repay the loan and retrieve your item, within a specified time frame. The downside is that if you do not repay the loan, the shop keeps your collateral. But this is often a better alternative than getting an unsecured payday loan and paying exorbitant fees that lead to a serious debt spiral.
Although it’s not ideal, a credit card cash advance can be an alternative to a payday loan. In fact, a credit card can work in emergencies instead of a payday loan. Rather than paying a 400% annual interest rate on a payday loan, you might pay a 25-29% annual interest rate on a cash advance from a credit card.
Finally, asking for a loan from friends or family to help get through tough times can be another option. Most people have relatives or friends who will lend them the necessary money to deal with unexpected expenses or emergencies. Typically, no interest or very little interest is added to these loans, and repayment can be arranged over time.
Just remember to be clear with the person you are borrowing from about how and when the loan will be repaid. Borrowing money from friends or family can strain relationships if not handled properly, so be sure to set realistic expectations from the start.
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Sources
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts in our articles. Read our editorial process to learn more about how we verify facts and maintain accuracy, reliability, and quality in our content.
Experian. “What Happens If I Don’t Repay a Payday Loan?”
Consumer Financial Protection Bureau. “What is a Payday Loan?”
Source: https://www.thebalancemoney.com/payday-loans-beware-of-these-dangerous-loans-1289623
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