In a word, no.
It is never okay to take out a payday loan. Not if you’re short on your rent, not if you need a new pair of shoes, and not even to pay for your weekly groceries.
Let’s talk about how payday loans work and why they’re such horrible short-term loan financing options.
What Is a Payday Loan?
A typical payday loan is a short-term personal loan that a consumer takes out from a payday lender.
Payday lenders typically require repayment for the loan, including interest, on the date of the borrower’s next payday. In some cases, lenders may extend the repayment date to thirty days.
On the due date for the loan, the payday lender typically debits the borrower’s bank account for the total loan amount plus any accrued interest charges.
Payday loans are usually for small amounts, typically up to $1,000, maximum.
Each state has the power to regulate payday loans. Some states cap the maximum loan amount at $500 or less, and a few minimize the interest costs a payday lender may charge.
Payday lenders typically charge high interest for their loans – sometimes up to 780% APR.
How Do You Qualify for a Payday Loan?
To qualify for a payday loan, consumers show proof of income, like a pay stub. Borrowers must have an open bank account and provide identification such as a driver’s license or passport.
Some payday lenders require borrowers to provide a post-dated check they can use to draft the borrower’s checking account on the repayment date. Online payday lenders require the borrower to give the authorization to debit their bank account through the ACH system.
There is no credit check to obtain a payday loan, making the loan a popular option for individuals with bad credit.
Borrowers who face unexpected expenses, like car repairs or medical bills, sometimes turn to payday loans for financial assistance. However, the high interest of a payday loan can quickly lead to a debt cycle that can be hard to get out of.
Why Are Payday Loans Such a Bad Option for Borrowing Money?
Borrowers often struggle to repay the loan in full on their next payday.
According to the Consumer Financial Protection Bureau (CFPB), up to 80% of payday loan borrowers renew their loans within 14 days of repayment. Of borrowers who choose to renew their loans, half of the recipients keep their loans for ten cycles or longer.
The average borrower does not reduce their principal amount in future loans. Instead, they continue paying interest on the same amount as the initial borrowing. Some borrowers increase their loan amount, furthering the vicious cycle of payday loan debt.
Organizations that offer payday loans may fall into the predatory lending category, especially if they charge high-interest rates and fail to consider the borrower’s ability to repay.
The CFPB found that the majority of payday loan borrowers receive government benefits. Individuals who rely on government benefits for income have little disposable income and may find it especially difficult to repay their obligation.
How Much Does the Typical Borrower Pay in Interest for a Payday Loan?
Consider an example of a consumer who borrows $500 from their local payday lender. The lender charges $15 per $100 borrowed every pay cycle. The borrower receives a bi-weekly salary, so their loan is due in 14 days.
The amount of interest for the first loan is $75, so the payday lender collects $575 on the repayment date. The $575 includes the principal of $500 plus interest of $75.
Unfortunately, the borrower can’t afford to repay the total amount of the loan on their next pay date. They agree to a loan renewal for $500, due on their next payday. The payday lender charges them another $75 in interest, bringing their total cost for borrowing to $150 for the first 28 days of the loan.
In our example, the payday lender charges interest on the loan equal to 391% APR – an excessive amount much more expensive than other lines of credit.
What Happens if You Don’t Repay Your Payday Loan?
If you fail to repay a payday loan, expect some financial – and even legal – repercussions.
Your payday lender will begin the collections process by directly debiting your bank account or attempting to cash your check. If there isn’t enough money in your account to pay the lender, your bank will charge you overdraft fees.
A payday lender may repeatedly attempt to debit your account. If their first attempt fails, they may try again as soon as the next day. You can easily find yourself several hundred dollars in the hole with your bank due to multiple overdraft fee charges.
As a result, you won’t only owe money to the payday lender but also be in debt with your bank.
Overdraft fees can impact your ability to pay for other items outside the payday loan. For instance, if you have other payments that haven’t yet cleared your bank, your bank will decline them if there isn’t enough money to cover them.
Collections Calls and Letters
Your payday lender will start sending you emails and letters to collect the money you owe them. Their first communications may provide you with options for a payment plan. For instance, they may allow you to make monthly payments on the loan until you pay it off.
The situation will worsen if you fail to respond to your lender’s collection attempts. They may contact you at work and send you increasingly threatening letters.
If it becomes clear you aren’t going to respond to your lender’s efforts, they may send your account to a collections agency or pursue a lawsuit against you.
A Debt Lawsuit
Payday lenders are known to file debt lawsuits against customers who fail to repay them per their agreement. If the payday lender wins their case against you, a judge will grant them a default judgment.
A default judgment allows the payday lender to garnish your wages, freeze your bank account, or even seize your property to satisfy the debt you owe. Default judgments can also damage your credit score.
You should file an Answer against the payday loan in response to their lawsuit. An Answer prevents the court from granting a default judgment against you without hearing your side of the story.
If a payday lender sues you, show up for your court date. If you don’t, a judge may issue a warrant for your arrest – which can result in criminal prosecution.
What Are the Alternatives to Payday Loans?
There are other alternatives for obtaining money when you have unforeseen expenses.
Credit Cards or Personal Loans
Banks and other lending institutions offer credit cards, even for people with bad credit. The interest for credit cards maxes out at 35.99% for those with less-than-stellar credit scores. Your credit card typically starts with a low limit, like $500 or $1,000. However, that amount should be enough to cover minor expenses.
If you have a relatively good relationship with your bank or credit union, you can obtain a personal loan with them. Under a personal loan agreement, you make fixed monthly payments until you repay the entire balance. Banks that grant personal loans offer low-interest rates, with a maximum of 35.99% APR.
Borrow From Family or Friends
If you don’t require a significant amount of money, a charitable friend or family member may be willing to loan you the cash you need. Explain your financial situation to your closest relatives or friends and see if they could let you borrow from them.
Most people don’t want to see their family or friends suffer financially. If they know you’re in dire straits, they’ll help you if they can.
Consider Selling Something
Look around your home and see if there is anything that you might be willing to part with for some extra money. Gently used clothing, antiques, jewelry, and electronics all have strong resale values. If the item isn’t particularly important to you, it may be worth selling on platforms like Facebook Marketplace or through your local pawn shop.
Take on a Side Hustle
If you regularly run into money issues, you may not have enough income to support your needs. Consider starting a second job until you can better manage your finances.
If your financial problems come from other debts you owe, use your additional income to repay your creditors. Consider credit counseling to learn how to manage your finances better and avoid getting into too much debt in the future.
Get On Top of Your Finances Without Getting Sucked Into the Payday Loan Trap
Payday loans are a form of predatory lending that takes advantage of people with few credit alternatives. Their high-interest rates and sometimes abusive collection practices can cause significant stress and anxiety for borrowers. Rather than relying on payday loans for financial emergencies or quick cash, take a holistic look at your spending habits and determine where you can make some cuts.
If you regularly need extra money, you should take on an additional job to improve your financial situation. While working long hours can be difficult, especially for individuals with families or other responsibilities, the extra income can help you build up your savings and eliminate the debt negatively impacting your disposable income.
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