Payday loans are short-term loans with low approvals and high APRs (up to 300%). Payday loans are the best option for financial emergencies, especially if you don’t have any savings or credit. However, their high-interest rates are often more harmful than beneficial.
You probably have heard of payday loans, even though you may not have ever used one. Payday loans are a good idea, and it’s a good thing you didn’t know about them.
They are one of those financial arrangements which are incredibly simple to enter but very difficult to exit.
Let’s discuss what payday loans are and how they work. And why you should always consider other options for this type of loan.
What is a Payday Loan?
A payday loan is a very brief-term loan. A payday loan is a short-term loan that lasts for a few weeks. These loans are usually only available from payday lenders located in storefronts. However, some are also available online.
People who are in urgent need of cash can use payday loans best. The entire application process is quick and easy.
Payday lenders will check your income and verify that you have a checking account with a bank. The income check will determine your ability to repay. While the bank account check confirms how much you will pay.
What is the process of payday loans?
Once your loan approval is granted, funds are transferred to the bank account. Even more important, your lender will require you to write a postdated cheque in payment of the loan amount as well as the interest.
Let’s take, for example, a $500 loan granted on October 16 at 400% APR. (Yes, payday loans have a standard 400% APR. The loan requires repayment within two weeks. You will send a check to the lender dated October 30, with the date of payment. You will receive a check for $575 and $500 to pay their loan, plus $75 for the interest for the next two weeks.
Postdated checks ensure that the lender will pay you back on the due date. They won’t even have to chase your money. Because payday lenders don’t look at credit history, the borrower can accept the postdated check arrangement.
Your paycheck will need to be automatically deposited into the bank by the lender. This will ensure that the account clears with the correct post-dated check.
Payday loans: Why do people get them?
Payday loans are a great option for people with bad credit. The borrower can apply for the loan and need not worry about their credit score.
Another natural market is those with low or no savings. According to a report by the 2022 Lending Club, 64% of Americans live paycheck to paycheck.
Bankrate’s 2022 survey found that 56% would not be able to pay an unexpected $1,000 bill with their savings.
You can also add current inflation rates to the equation and see why payday loans are so popular.
Payday lenders are able to help people with bad credit or lack of savings because they have access to a large market. While many people can get by with little savings, there are times when an emergency situation calls for cash.
Let’s say, for example, you have poor credit and no savings. It will cost $700 for you to fix your car. The car is essential to your ability to commute to work. You don’t have any savings or credit available so you turn to payday lenders. The loan allows you to borrow $700 plus interest in just two weeks.
Pew Charitable Trust estimates that 12,000,000 Americans use payday loans every year and spend $9 billion on loan fees. Federal lawmakers are working on lowering payday loan rates, which range from 400% to 36%.
Although payday loans are commonly used to replace emergency savings accounts, many people also use them for their regular living expenses.
Payday loans: What is so bad?
Payday loans have the most obvious drawback: their high cost. For a $500 loan, a borrower would pay $75 in interest. The interest rate would be 15% if that were the annual cost of interest. This rate would be acceptable for anyone with bad credit or no credit and who is applying for an unsecured loan.
The $75 interest rate is charged for only two weeks. This is even more alarming because the interest rate is charged to those who cannot afford it. A person who doesn’t have $500 right now is unlikely to be able to afford $575 in the next two weeks. They’ll need to come up with the rest.
It gets worse
Payday loan users often find themselves in an endless cycle of payday loans. A payday loan can lead to the need for another, which in turn leads to the need for a third.
The problem is, the borrower will need to get another payday loan in order to pay the first one. The reason they took the first payday loan was to cover an unexpected expense. They won’t be better off in two weeks because their regular earnings will be used by regular expenses.
Lenders may offer continuous financing, by rolling the loan over every two weeks. While the borrower will be required to pay interest every two weeks the original loan balance will not change.
The borrower will need to pay $75 every 2 weeks. This means that he will end up paying $1950 in interest over the course of a year in order to receive the $500 loan.
Payday loans do not exceed $1,000. Payday lenders are acutely aware of the fact that the probability of repaying a loan falls with increasing size.
Lenders are notoriously aggressive when it comes to the collection if you fail to pay your payday loan. Not only will you be harassed by collection calls and threats but also, almost certainly, you will be served with a judgment from the court.
Payday loans can trap you in a cycle of debt. It can seem impossible to have a choice when you are in an emergency. Payday loans can negatively impact your credit and any savings that you may have. They could even land you in jail.
There are many options for payday loans, and they can be very good. These are the alternatives to payday loans. Getting a loan with 300-500% interest for a few weeks is not the best way to go.