Everyone has financial difficulties sometimes. There will be times in your life where you get an unexpected bill, or perhaps if you’re self-employed, you may not have a great month financially. Either way, during these times, you may need cash that just isn’t in your bank account.
For many people, simply tapping into your savings to help to tide you over until that next elusive paycheck comes around isn’t necessarily an option.
One option to help you get through your financial struggles is to take out a payday loan.
Yes, there is a stigma around payday loans. They’re largely used by low-income individuals making less than $30,000 per year, and the interest rates are often high, resulting in over 80% of payday loan repayments initially not being met. This article will discuss these types of loans, and evaluate whether they’re a good or bad financial product.
- Payday loans are a form of short-term loan offered by lenders in smaller quantities, typically around $500 – $1000.
- Payday loans are often considered to be a predatory financial product due to the demographic that they’re used by and the ease of obtaining them.
- The stigma around payday loans stems from the fact that they often can’t be repaid, and, this being the case, will resultantly leave the borrower in a cycle of debt.
- However, there are pros and cons to payday loans. See below.
What are Payday Loans and how do they work?
Payday loans are a form of short-term loan offered by lenders in smaller quantities, typically around $500 – $1000.
Payday loans work best for people who need cash in a hurry. That’s because the entire application process can be completed in a matter of minutes.
Payday lenders will verify your income and a bank checking account. They verify the income to determine your ability to repay.
When your loan is approved, the funds are deposited into the verified bank account. But even more important, the lender will require that you write a postdated check in payment of both the loan amount and the interest charged on it.
For example, let’s say that you’re granted a $500 loan on January 16th. Since the loan will often require repayment within two weeks, you will write a check back to the lender that’s dated for January 30th. The check will be for $575 – $500 for their loan repayment, plus $75 for interest.
The postdated check ensures that the lender will be paid back by the scheduled date and that they won’t have to chase you to get it.
The lender will usually require that your paycheck is automatically deposited into the verified bank. The postdated check will then be set to coincide with the payroll deposit, ensuring that the post-dated check will clear the account.
That’s why they’re called payday loans.
Why do Payday Loans have a ‘stigma’ around them?
The stigma around payday loans stems from the fact that they often can’t be repaid, and, this being the case, will resultantly leave the borrower in a cycle of debt.
Statistics suggest that only 14% of payday loan borrowers are able to repay their loans. Subsequently, repeat borrowing rates are very high with 1 in 4 payday loans rolled over or re-borrowed at least 9 times.
Despite being advertised for emergency unexpected paychecks between payments, 7 in 10 payday loan borrowers are relying on them to cover regular monthly payments such as rent and utilities. Thus, if they are relying on these loans to cover their basic costs, their income is evidently not high enough for their basic living expenses.
Moreover, payday lenders are more open to lending to people who typically have poor or bad credit ratings, which is why these candidates are often unable to secure loans from traditional lenders. Their bad credit implies that they are not able to meet a specified repayment plan, and lender sometimes take advantage of this by offering loans with higher interest rates.
Pros and Cons of Payday Loans
Despite the stigma surrounding payday loans, it is still important to weigh up the pros and cons of this financial product so that you, the consumer, can decide for yourself whether a payday loan would suit your personal needs.
Pros of Payday Loans
- Quick Cash: with payday loans, getting cash quickly is a feature that payday loans have over its traditional competitors, that require an application and then later a check to submit to your bank account. Both the approval process and the cash may deliver in less than 24 hours for some applicants.
- Easy Approval Terms: getting approved for a payday loan is not as hard or time-consuming as it is for a traditional loan. In fact, most applicants are quickly and easily approved for the loan. This is a leading advantage for small cash loans and fast payday loans that are offered by short term loan lenders.
- Lenders Available Online: while there are several pros and cons of payday loans, online lender access makes this option a real convenience for those who need cash fast.
- Unsecured Loan: unlike a car title loan, traditional auto loan or mortgage, payday loans are not secured by personal property. This means that if you default (don’t pay), the lender can’t seize your property as a consequence.
Cons of Payday Loans
- They’re Expensive: depending on the state, payday loans have high interest rates that average about 400%. For comparison, many personal loans charge about 4%-36% interest, while credit card interest ranges from about 12-30%.
- Payday loans are considered predatory: a predatory loan is defined as having unfair, misleading or unaffordable terms and has the potential to trap users in a cycle of debt. Payday loans are viewed as a type of predatory loan because of the high costs that can escalate quickly.
- Easy to get trapped in a debt cycle: each time you extend (rollover) a loan, a payday lender charges additional fees, increasing your out-of-pocket costs for borrowing the money. In fact, 1 in 4 payday loans are borrowed more than 9 times.
- Can be sued by a lender: just like other lenders, if you fail to pay a payday lender for long enough, they can take you to court and try to get a judgment against you for failure to repay a debt.
Alternatives to Payday Loans
If you have decided that a payday loan isn’t right for you, there are some good alternatives for you to consider to help you through your time of financial need.
While personal loans or unsecured loans are harder to get approved for, some are open to borrowers with bad credit. Make sure to look at credit unions and online lenders, which may be more flexible.
Borrow from Family or Friends
You can offer to pay interest. To avoid conflict, it’s wise to get the agreement in writing.
Loan from a Peer-to-Peer Marketplace
Online platforms like Prosper and Peerform match investors with those in search of funds and may provide more affordable options than certain other loan types.
Earn Additional Income
Earning extra cash could be one way to avoid taking out a payday loan, whether this means pulling extra hours at work, finding a short-term part-time job or getting a side hustle.
Another option is to ask your employer for an advance on your paycheck. Most companies are happy to help you out financially with an advance on your paycheck, as long as you don’t abuse this form of financial assistance.