Payday loans seem like a great idea, in principle.
You get a small loan to help you pay bills until you get your next paycheck.
You pay back the loan plus a small amount of interest, sounds great, right?
Well it’s not so simple, and often times these types of loans backfire, resulting in more financial hardship.
What is a Payday Loan?
A payday loan is a short term loan, usually for less than $500 with a high interest rate. These short-term high cost loans are often paid back within a few days, when the borrower gets their next paycheck, hence the name, payday loans, or payday advance.
They are repaid in full, payday lenders do not take payments for less than the full amount. The average interest rate for a payday loan is 400%.
Payday loans are highly regulated by the Consumer Financial Protection Bureau (CFPB), you need to check the legal status in your state.
When is a Payday Loan a Good Idea?
Payday loans aren’t always bad, there are situations where a payday loan can actually be useful. If you’re facing an emergency and simply cannot wait for your check, then a payday loan can be a life saver, literally.
Here are some situations in which it’s okay to get a payday loan
- To have a vehicle repaired if it is not operational
- Pay past due rent or mortgage
- Keep utilities from being turned off
- Pay past due credit card or other bills
- Medical emergencies
The Payday Loan Cycle
Some borrowers often find themselves in a never ending cycle of payday loans. When you do get a loan, and you pay it back when you get paid, you lose a lot of money to the higher interest charged.
This can cause you to need another payday advance to meet your financial obligations. This cycle happens to borrowers who become dependent on these loans to get them to their next paycheck, or social security payment.
If at all possible, you should avoid these types of short-term high interest loans, unless it’s an absolute necessity.
Payments are Automatically Withdrawn
Often, lenders will want your bank account information on file to automatically deduct funds from your account to repay the loan. Because payday loans have very high interest rates the amount they deduct can be much more than you except.
Watch Out for Predatory Lending
While the payday loan industry is much more highly regulated now that it has been in recent years. Many payday lenders still take advantage of desperate borrowers, charging higher rates and fees than the law allows.
Make sure you know the payday laws in your state before you accept a loan.
Payday Loan Alternatives
If you’re in need of some extra cash to pay your bills before you accept a payday loan, know the alternative financial solutions.
A personal loan is an unsecured loan that does not require collateral such as a home or vehicle. Lenders look at your credit score to determine the amount you qualify for, and at what rate.
Personal loans are typically for between $5,000 – $40,000 with a 24-60 month repayment schedule. Interest rates can vary, and largely depend on your credit score, but they range between 12%-25%, making them much cheaper than payday loans.
A credit card is a revolving line of credit that you can borrow from on an as-needed basis. If you find yourself relying on payday loans a little too much, a credit card is the perfect alternative.
While credit card rates are usually high, between 10%-20% they are still much cheaper than payday loans. A key benefit of using credit cards is that if you’re able to pay the balance in full when the bill is due you won’t be charged interest. And you are only charged interest on the amount you borrow.
If you have credit card, but you need cash. You can get a cash advance from your creditor, you may have to call them to get it set up. It requires a pin code and the interest rate will be higher than if you use it as a charge card.
Home Equity Loans
If you’re a homeowner with equity built up in your home, you can use that equity as collateral for a loan. Home equity loans are secured by your home so they are a risky alternative to a payday advance, but they do have much more attractive terms.
Interest rates are typically very low, below 8%, and have long repayment terms between 5-10 years. A HELOC, is a home equity line of credit that is similar to a credit card. You are only charged interest on the amount you borrow.
Be Sure to Avoid Title Loans
Title loans may seem like a great alternative to payday loans, the opposite is true. Title loan terms are very similar to payday loans with an average interest rate of 300%. Except they are installment loans that are secured by your vehicle.
Usually title loans are to be repaid within one month, with a 25% monthly interest rate. If you cannot afford to repay the loan in one month, the balance is rolled over to the next month with another 25% monthly rate.
The Bottom Line…
Payday loans have a very bad reputation, and for good reason.
Extremely high finance charges put consumers in very difficult financial situations. If at all possible you should avoid payday loans at all costs.
Check into the alternatives first. Credit cards can give you that extra money you need, when you need it, for a fraction of the cost. Personal loans are also a great alternative with modest rates and a longer repayment term of 24-60 months.
The Lenders Network has the largest network of mortgage lenders that specialize in home loans for borrowers with all types of credit scores. We will match you will the best lender based on your specific situation.