The ads on storefront windows and television ads make payday loans appear to be the easy solution for some quick cash if there’s too much month left at the end of the money. Almost anyone with a steady job and a bank account is accepted – even with bad credit.
Beware: Payday loans come with an extremely high interest rate and are designed to keep their customers borrowing for more than a few days.
How Payday Loans Work
The process is simple: Complete a short application, write a check dated on the next payday and receive a lower amount of cash in return. Fees and interest are generally an amount per $100 needed – and taken out before you receive any money.
A $300 loan will generally net $210 in cash that can now be used to solve the emergency.
If you don’t have the money on the next payday, the lender will allow you to renew the loan if you pay another fee – leaving the principal still outstanding.
Why You Should Avoid Payday Loans
Payday loans are not the easy cash solution to a financial crisis. The interest rates are terribly high and most customers aren’t able to payoff the loan when it comes due – creating a vicious cycle.
High interest rates.
Most of us think about interest rates in terms of years, not days. A $30 fee on a $100 loan is 30% interest – a little higher than some credit cards. Right?
Wrong! It just depends on the length of the loan. When money is loaned for only a few days, the effective interest rate soars.
Check out some scenarios on the calculator provided by the Missouri Attorney General Offices! A $300 loan with a $90 fee for 7 days equals a 1580% effective interest rate with several renewals!
Difficult to payoff.
The check written for the payday loan is going to be presented against your checking account in a few days. Not only is the check for the amount of the bill that needed to be paid but also includes that additional fee.
There’s a good chance there isn’t going to be enough to cover the check. The household budget is running too tight for that kind of hit. You run to the Easy Cash Store to stop the check from going to the bank.
The Payday Lender is happy to “churn” the loan if you only pay the fees again. The $90 fee is manageable compared to having $300 taken out the checking account that will create a domino effect of an overdraft and service charges.
Unless something changes, there’s a good chance the loan will continue to “churn” with another $90 fee in a few weeks.
After only a couple of months, the fees paid to the lender now exceed the principal and the $300 is still due. Remember, you walked out of the payday store with only $210 in your pocket.
The statistics aren’t in your favor.
The Center for Responsible Lending highlights some scary facts:
- Only 2% of customers use a payday loan only one time
- 75% of payday loans are “churned” or renewed every pay period
- $3.5 billion dollars are charged in fees each year
- 90% of borrowers have more than 5 loans per year
- A $325 loan that is flipped 8 times results in $468 interest. Total repayment – $793.
How to Spot a Payday Lender
Payday lenders aren’t always just another tenant in the strip mall.
Banks & credit unions – Big banks and local credit unions offer unsecured loans that are typically due on the next payday. While credit unions now cap their interest rate at 28%, many refer customers to the big triple-digit-interest-rate payday lenders for a fee in return.
Phone – A catchy jingle on the radio might come to mind when a bill is due now but payday is next week. Personalities like the late Gary Coleman, and Montel Williams, spout the ease and benefits of picking up the phone to solve cash problems.
Internet – The Internet makes payday loans very accessible! But personal and bank account information transmitted over the Internet gives these businesses instant access to take out the next round of finance charges when the balance cannot be repaid. Sometimes it’s very difficult to get the loan repaid with these Internet sites.
Alternatives to Payday Loans
The need for a payday loan is generally a symptom of a budget being out of balance and not a rare financial emergency. A little planning ahead of time can help many families avoid the payday loan cycle.
- Set aside a little amount from each paycheck for an emergency fund. Even a few hundred dollars can save the day with many emergencies. The average payday loan is between $50-$500.
- Before the next money crisis, sell items from your household that you no longer use or need on Craigslist, eBay, consignment shops, or a big garage sale. Set aside the cash for that rainy day.
- Cut back on all spending except for basic food items and gas. You’d be surprised how many meals can be made from food in the freezer and pantry with a few fresh additions from the store.
- Add another income to the household with a part-time job. A few extra hours a week can build up a cushion.
- Talk to creditors about your situation and see if there is some relief in terms of minimum payments, interest rates, due date, etc.
- Calculate the late fee on the bill that’s due. Chances are it will be less than the finance charge on a payday loan. That late fee might also give you a month to come up with the money rather than days.
- Ask your employer about a small advance before payday. For a true emergency, many businesses would be willing to help out once.
Have you ever been so strapped for cash that you went to a payday lender? Do you have friends or family members struggling to get ahead of their payday loans?