Payday Loans

For people who are struggling to make ends meet, payday loans hold a certain appeal.

 

A single unexpected ticket or fee can leave you scrambling and unable to pay a bill. Late fees can pile up, which could lead to an increasing inability to make the payments you need to make. Payday loans are designed to function as a stopgap. So long as you can prove that you have a job, the payday lender will give you a small, short-term loan, usually no more than $500. It has a high interest rate, but if you pay it off by the time your next paycheck arrives, there is a good chance it will be cheaper than paying the late fee. These payday loans work for some people, but they are also controversial, as they can trap people in a cycle of debt.

How Payday Loans Work

Getting a payday loan is relatively simple, assuming you do not live in one of the 18 states that has outlawed this type of loan. The most difficult part is finding a payday lender near you. Once you have done that, you will only need three items:

  • An ID
  • Recent pay stubs, which will prove you are currently employed
  • A post-dated check, which the payday lender will cash if you do not pay them back by the due date of the loan

This type of loan does not require a credit check, which means your interest rate will not be impacted by your credit score. This can be appealing for borrowers with no credit history or a poor credit score. However, it is important to keep in mind that the interest rates for these sorts of loans are higher than even the most expensive rates for credit cards given to individuals with a low credit score.

It would not be unusual to see a 400% interest rate, which means you would be paying the lender over four times the cost of the loan that you initially procured if it took you a year to pay back the loan. However, these loans are meant to be short-term, generally lent out for anywhere from two weeks to a month. This means the average you can expect to pay is $15 for every $100 you borrow. This is still expensive at 15%, so you have to decide if you truly need the money ahead of time.

The law provides special protection for service members, which means that lenders are not allowed to charge service members or their dependents rates that are as high as the normal rate for payday loans. The maximum annual interest rate that a lender is allowed to charge service members is 36%. This rate is still higher than most other loans, but it does mean there is less risk involved in these loans for service members and their families than there is for other individuals.

When You Should Get a Payday Loan

In general, there is never a right or wrong time to get a payday loan. Their high interest rates have led many people into a cycle of debt and poverty, which is why they have been outlawed in 18 states. Many politicians advocate banning them under the premise that these institutions practice predatory lending. If you can avoid payday loans, it is best to do so. However, these loans have been shown to work out for individuals who plan carefully. According to one study, 60% of borrowers pay off the loan when they expect to. A payday loan can be useful if you are using it for the right reason and plan to find financial alternatives in the future.

Payday loans are more troubling when you are using them as more than a temporary stopgap measure. If unexpected bills prevented you from having the required money for one month, a payday loan can help. But if you are using a payday loan because you do not have enough money to pay for items like food or rent, you need to get your finances in order to put yourself on more stable financial footing.

 

Research shows that at least 10% of the individuals who use payday loans do not have a strong understanding of their financial future. These people will get caught into a cycle of debt and will be forced to continually make payments on their payday loan. Paying a payday loan on time will generally not impact your credit, as these lenders do not usually contact credit bureaus to let them know that you have paid on time. However, if you do not pay your payday loan on time, the payday lenders may let the bureaus know. If they do not, they will likely do one of two things. They will either use the threat of informing these bureaus as leverage to get you to pay, or they will sell your loan to a credit collection company, which will then inform the bureaus.

Alternatives to Payday Loans

The high interest rate that comes with a payday loan means that this sort of financing is not a long term solution. If you find yourself feeling the need to take a payday loan, it should be a wakeup call regarding the state of your finances. Here are some alternatives that you can use to avoid payday loans:

  • Asking friends and family for a loan until your next paycheck may be uncomfortable, but assuming they do not charge you interest, it is a much safer financial move.
  • Change your work situation, either by finding a higher-paying job or a second part-time job, in order to give you the cash flow you need.
  • Improve your credit so that you can use lending services that do require a credit check.
  • Using credit cards during emergency situations is risky, since you can build up debt that it is difficult to pay off, but since credit cards provide lower interest rates, they are preferable to payday loans.
  • In the future, putting together an emergency fund can help you cover unexpected expenses without taking out a loan.

If you find yourself in an unexpected emergency, payday loans can help you get your finances back on track with a small loan. However, they are not a long-term solution, and it is worth improving your financial situation so that you have more options in the future.

 

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