Payday loans are small-dollar, short-term loans designed to help people strapped for cash between paychecks. They are easy to obtain but expensive, and becoming reliant on them can lead to a spiral of debt that is hard to recover from. Before deciding, it is important to understand how payday loans function, considering their pros, cons, associated risks, impact on credit score, and overall cost.
By examining the important factors outlined in this article, you can make a knowledgeable decision that meets your financial needs while avoiding the potential pitfalls of high-cost borrowing.
Payday Loans Explained: How Do They Work?
Payday loans are short-term, high-cost unsecured loans planned to be repaid on the next payday within two to four weeks. These loans can provide a quick source of funds for those needing urgent cash. Payday loans often have a set fee structure that can vary depending on the loan amount, state regulations, and individual lender policies.
To obtain a payday loan, a borrower completes a loan application and provides their pay stubs as proof of income. The loan amount is small and usually $500 or less, with the fees charged as a percentage of the loan amount. The fee for a payday loan is $15 for every $100 borrowed, which translates to an exorbitant annual percentage rate (APR) of almost 400%. In contrast, the APR for payday alternative loans doesn’t exceed 28%.
To secure the loan, the borrower issues a postdated check for the full loan amount plus the fees charged. Alternatively, the borrower may authorize the lender to withdraw the loan amount plus fees electronically from their bank account on the loan’s due date.
Thinking About a Payday Loan? Consider These 5 Factors Before You Borrow
Before opting for a payday loan, it is advisable to explore other alternatives. Payday alternative loans online are a safer and more affordable option some credit unions offer. If a PAL is not available to you and you are considering a payday loan, there are several factors to consider before borrowing:
- Calculate the Total Expense
Payday loans frequently carry exorbitant fees and interest rates that can significantly increase the amount you need to repay. For instance, lenders charge interest of $10-$30 per $100 borrowed, which could result in paying back $50 to $150 in interest on a $500 loan. The fees and penalties can increase if you can’t repay the loan on time.
- Risks Associated: Know the Consequences of Missing a Payment
If you bounce a payment, both the lender and your bank will charge you additional fees, and the amount you owe will continue to increase until it is paid in full. Your account may be handed over to a collection agency and added to your credit bureau, damaging your credit score.
- Verify State Licensing of the Lender
Online lenders, in particular, can be risky, as they may not be licensed in your area, allowing them to impose arbitrary terms and charges. Some online lenders even share your personal information with other payday lenders. It would help if you only borrowed from licensed lenders who are reputable and fair.
- Don’t Skip the Details
You must read the fine print and understand the terms and conditions outlined, including interest rates, fees, due dates, and the total cost of the loan. This information is important to avoid surprises and ensure you are fully aware of the obligations and consequences of taking out the loan.
- Ask Probing Questions
Ask the right questions to understand the terms and avoid surprises fully. It would help to ask whether the lender is an actual lender or a lead generator and how your personal information will be protected. You should also ask if the lender will pull your credit report or seek other information from credit reporting companies.
Many people who live paycheck to paycheck often turn to payday loans to cover unexpected expenses they cannot afford with their current income until their next paycheck. Considering the abovementioned factors can enable borrowers to make an informed choice that caters to their financial requirements and helps them evade the possible downsides of borrowing at high costs.