If you have ever needed an influx of cash quickly, you may have found out that getting a loan can be difficult. Most of them, such as mortgage and business loans,are earmarked for very specific purposes that may not exactly align with what you are trying to do – and personal loans can be difficult to qualify for with a poor credit score, or otherwise take a long time to process.
Due to this perceived gap in temporary coverage options, certain loan agencies have established specialized smaller loans, known as payday loans. While sometimes effective, these can be highly controversial due to their many, often unadvertised downsides.
What are payday loans?
Generally, payday loans are often loans for low amounts (averaging around $500) that have short repayment terms and high interest rates. They are often used to hold people over until they receive their next paycheck – hence, their name being “payday” loans. They are usually repaid in one bulk payment on the day that you receive your paycheck. But instead of charging interest on a monthly basis like a normal loan, they add up interest charges for every day that passes before you pay off the loan.
Payday loans are called different things, depending on what kind of agency is selling them. Some of their many names include cash advances, credit access, deferred deposits and more. But, they are all basically the same thing. On top of the interest rate that they charge along with the original amount of the loan, many payday lenders have one-time service fees that are factored in to how much you must pay at the end of the loan term.
Why are payday loans generally considered to be harmful?
There are a variety of reasons to avoid payday loans, in order to protect your financial stability and avoid predatory lenders. Some of the most common and relevant reasons include:
- They may be illegal in your state. Believe it or not, many states have begun to crack down on payday lenders by setting mandatory maximum interest rates. However, some payday lenders can slip through the cracks, by marketing themselves as something else or even participating in shady backroom deals. Always check the legitimacy of your money lenders carefully, and ensure that your state is not one of the 17 (and growing) states to ban or heavily restrict payday lending.
- They have extremely high interest rates. Without a doubt, payday loans can have some of the highest interest rates (also called annual percentage rates, or APRs) of any other loan type. Among those states that do not regulate payday loans, the average APR can be somewhere around 400 percent of the cost of your loan – and they can even range as high as 5,000 percent if you agree to a particularly bad deal. However, some states have set restrictions on payday lending while not banning it outright – and among these states, they can range between 24 and 261 percent. For context, the best peans can give you interest rates of two to eight percent APR.
- They can be habit-forming. Payday loans are not a permanent solution, due to having short (often 2-3 week) terms. However, many Americans view them as something that they can utilize indefinitely – after paying off their loan upon receiving their paycheck, these individuals then go on to take out another payday loan near the end of the month when they need more money quickly. This amount that they are paying in interest and service fees adds up very quickly, and many payday loan users und up spending much, much more on those additional costs than they do on the original loan debts.
- They can hurt your credit score if used improperly. If you fail to pay your payday loan agency on the day that you are asked to do so, you may be subject to fees, damaged credit and even lawsuits. Allowing your debts to go to a collections agency or filing for bankruptcy are both bad options, as those acts will stay on your credit report for quite a long time, further limiting your loan options in the future.
Why and How You Might Get a Payday Loan
You should only ever consider getting a payday loan if you have a financial emergency, and cannot get funds to pay for that emergency any other way. But if that is the case, you should learn how to get one without becoming trapped in a cycle, as so many other Americans have. To prepare for a payday loan (if it is legal in your state), you must:
- Be 18 years of age or older.
- Have an active bank account.
- Have an ID card from the state that you are trying to get the loan in.
- Provide proof of income (such as with a pay stub) and inform the agency of the date that you will be able to pay off your loan.
While you do not need a good credit score to get a payday loan, lenders will often do a bit of research to ensure that your information is correct, that you do not have an outstanding or unpaid payday loan already and that you are able to pay for your loan once you receive your next paycheck. Active-duty military members are also protected by regulations from the federal government, whose payday loan interest rates can be no higher than 36 percent APR.
Once you have provided the required information to your lender and paid their early fees, you will be able to receive information about your further payment options. Then, you can get your loan as early as the day of your application (although it usually takes at least one day to process everything).
Good Alternatives to Payday Loans
If you can afford to do so, there are other ways to go about paying for a cash emergency. Some of these methods include:
- Asking friends or family if they can lend you money to cover the emergency.
- Asking your employer for an advance on your paycheck.
- Checking with your local bank or credit union to see if they can offer a smaller personal loan at a lower rate than payday lenders.
- Using a credit card, assuming you can responsibly pay those debts and interest rates when that occasion arises.
- Negotiating with your creditor to see if there are other payment plans, or simply if they will give you extra time to pay off your debts.
It can be difficult to do some of these things, especially when you have had financial troubles in the past. However, it is crucial to consider all of your available options before you decide to take the risk on a payday loan – and if you do decide to take on such a risk, you must be aware of how to limit your spending and future debts as much as possible.