It’s easy to see why payday loans are so tempting.
Consider this scenario, for example. You’re $300 short on an important bill. Your next payday is 10 days away, your credit card balance is at its limit, and you can’t borrow from any of your friends or family. What do you do?
The answer isn’t straightforward because there aren’t a lot of stellar options in such situations. In this scenario, you might be tempted to use a payday loan, which can bridge the gap in your finances, but it likely will plunge you further into debt.
If your situation seems desperate, you can explore alternatives to get the money you need. Understanding how payday loans work and determining your options will empower you to make a wise financial decision.
How do payday loans work?
When you get a payday loan, you use your paycheck as security against the amount you borrow. When you apply for a payday loan, it doesn’t matter if you have bad credit or no credit, because the lender has the authority to take its payment from your bank account when you get your next paycheck. That’s how payday lenders minimize their risk.
How can they do this? When you’re approved for a payday loan, you give the lender a postdated check that it can deposit on your next payday. If you take an online loan, you authorize the company to take the funds from your bank account once you’re paid by your employer.
Risks of payday loans
Payday loans can sometimes seem too good to be true, because they’re more accessible than a personal loan or a credit card cash advance. But if you’re not careful, payday loans can be dangerous and can cause your credit score to plummet.
When you’re short on cash, It’s easy to minimize the effect of a payday loan fee. It’s natural to assume you’ll be able to pay the fee plus the principal on your next payday. However, your paycheck usually is needed to pay for other expenses. Even if you try to set aside money to repay the payday loan, unexpected costs can derail that goal.
Perhaps you planned to cut your gas budget the next month to pay back the loan. But if the cost of gas goes up, your plan could unravel. If you can’t repay the full loan amount, you’ll have to roll over your loan.
“You get in this vicious cycle if you don’t pay it back when it comes due,” said Katie Ross, an education and development manager at the nonprofit American Consumer Credit Counseling. “Then you’re going to continue to get interest and fees on top of that every time you’re late.”
It can be difficult to get out of this cycle once you’re in it. “Unless you have a plan to repay the loan quickly, it’s most likely only going to worsen your debt situation,” said Ross.
“The larger your paycheck, the more likely you are to be able to set aside funds to repay your payday loan,” she added. “But if your paycheck isn’t much more than what you’re borrowing, or if you have a number of other bills to pay, you can see where the trouble starts.”
How do I repay a payday loan?
Usually, payday lenders charge you a fee for every $100 you borrow. The fee can range from $10 to $30, according to the Consumer Financial Protection Bureau, depending on the lender and where you live.
Those fees might not sound like a lot, but they can add up. An average $15 fee can equate to an APR of almost 400% for a two-week loan.
You’re expected to pay back the entire loan and fee on your next payday. Unlike with a personal loan, you often can’t make installment payments on a payday loan. If you don’t have the money to pay off the full amount on your next payday, you might have to roll the loan over to a future payday. Of course, you’ll accrue more fees in the process.
Imagine this scenario: You borrow $100 and owe $115 when the lender’s fee is added. Two weeks later when the loan is due, you realize you can’t pay. So you pay the $15 fee and roll the loan over — meaning you owe $115 again because you haven’t paid back any part of the principal and you have a new $15 fee.
That fee might look small when you first take out the loan, but if you keep repeating the rollover cycle you can end up owing more than the amount you borrowed in the first place.
How do payday loans affect my credit?
Unlike other types of loans, applying for a payday loan is less likely to make an impact on your credit score. Because payday loans are intended to be small loans taken out for the short term, most lenders don’t require a hard pull of your credit score to determine if you’re eligible for a loan.
Payday loan payments are generally not reported to the major national credit bureaus. If you are able to repay your loan in full within the allotted time period, your credit score will remain unchanged.
However, a payday loan will impact your credit score if you can’t pay your loan back. If you don’t have sufficient funds in your account, your payment will bounce, and your bank could close your account and send you to collections.
Similarly, some lenders may bring you to court in order to collect your unpaid debt. If you end up losing your case, that information could be reflected on your credit report, lowering your score for up to seven years.
Payday loan alternatives
You might not be able to get a traditional bank loan to meet your quick-cash needs, but some of these methods to stretch your finances to the next payday might work better than a payday loan.
1. Use a credit card
If you have a credit card that’s not maxed out, you could use it to charge your expenses. Not only will your interest rate likely be lower than on a payday loan, but you’ll have 30 days to pay back the credit card balance before it incurs interest. If you can pay back the money by your next payday, a credit card could be a cheaper option.
2. Get an installment loan
An installment loan allows you to borrow a set amount of money over a fixed time period. Some common examples of installment loans include car loans, mortgages and student loans. You repay the loan over a certain number of payments, called installments. Most installment loans will have a fixed monthly amount that you’re required to pay, and the amount won’t change over the course of your repayment period.
Installment loans are beneficial because they come with a predictable monthly payment. Knowing how much you need to pay each month can help you budget for your monthly installments, and avoid missed payments because of unexpected fees.
Keep in mind that installment loans don’t allow you to increase the amount of money you need to borrow. If you need more funds unexpectedly, you’ll have to take out a new loan.
3. Apply for a personal loan online
It’s possible to get a personal loan with bad credit. Some online lenders, such as LendingClub and Earnest, have loans for as low as $1,000 to $2,000. Avant requires a minimum credit score of 600 with an estimated APR that ranges from 9.95% to 35.99% — significantly lower than the estimated 400% that you’d be facing on a payday loan.
You can check your best personal loan rates online and it won’t impact your credit score. Once you’re approved, the money is sent to you within one business day.
4. Consider a credit union if you have time
Credit unions offer payday alternative loans (PALs) that allow you to borrow between $200 and $1,000 for a term of one to six months. The APR is capped at 28.00%.
But you have to be a member of a credit union for at least a month to be eligible to apply for PALs. So they won’t be the best solution if you need money immediately.
5. Turn to family and friends
Friends and family might not always able to lend money, but sometimes they can help in ways that can lessen your expenses. They can let you do your laundry at their place, which can save your costs at the laundromat. Or they can make dinner for you and give you leftovers that will last until payday. Or maybe they can lend you money.
Don’t be afraid to open up to people who are close to you about your financial struggles. It takes a village — and one day you’ll be there for them, too.
6. Generate income quickly
There are a few things you can do to generate extra income quickly. One way to make extra cash is by selling some of your stuff that you can live without. Have clothes you can get rid of? Try selling them online or at local secondhand stores.
You also can explore renting out a room on Airbnb, trading in your unused gift cards for cash, or cashing in any unused rewards points on your credit cards.
7. Ask you employer for an advance
Check with your employer if you can get an advance on your paycheck to tide you over. Ask your HR or payroll department if the company can find a way to help you out.
8. Seek leniency to reduce or delay payments
If you owe money on certain bills, it’s a good idea to call each creditor to request an extension on your balance due date until you have the money to pay it back.
Many companies will agree to this leniency or find ways to allow you to make partial payments on your bills. It’s worth checking areas where you can lower or hold off payments to get you through till payday.
9. Use emergency relief services to reduce your expenses
You might be able to save up for any upcoming payment by eliminating other expenses in your budget by using emergency aid services in your community. Here are some ways:
- Local food banks: Reduce or eliminate your grocery bill by accessing the resources of a food bank in your area while you wait for your next paycheck.
- Low Income Home Energy Assistance Program (LIHEAP): This is a program run by the federal government to help families meet their energy needs. The LIHEAP program also offers annual grants, which can’t provide emergency cash because you need to apply by September . However, you could use it to plan for the future.
- Local community service agency: Many communities have nonprofit organizations that help residents in times of need. For example, Community Services Agency in Mountain Park, California, offers help with rent, utilities, and back-to-school expenses. Some local churches or other religious institutions offer similar services.
10. Consider pawn loans
You could borrow money from a pawnshop by using one of your valuable items as security against your loan. The pawnbroker will hold the item and lend you an amount that typically is a portion of the resale value of the item, often for a high fee.
If you make payments on this loan, you’ll be able to redeem your item. If you stop making payments, the pawnbroker eventually will sell your item to recover its loss.
But a pawn loan is an expensive way to borrow money. When you average its fees over 12 months, the total equates to an APR of about 200% — or about half the cost of a payday loan.
Pawnbrokers don’t report your payment history to consumer credit agencies, so if you don’t pay off your loan it won’t impact your credit. But you’ll lose the pawned item.
The term length for a pawn loan is 30 days, which gives you some time to get the money together to pay it back.
How to choose the best option for you
However, it’s easy to get caught in a cycle of debt with a pawn loan, so it’s better to find other ways to make it through to the next payday.
If you need money immediately, use this criteria to determine which quick-cash alternative method is right for you:
- Which loan will have the lowest interest? You might have an easier time repaying a loan if it has lower interest. In general, it might be possible to negotiate terms with lower interest rates on loans from family members and friends.
- Can you build your credit? It’s better to build your credit before you get a loan, but if that’s not possible, getting a loan from an institution that will help you simultaneously build your credit — such as a payday alternative loan from a credit union — could be a good way to get the money you need while also boosting your credit history.
- Can you repay the loan while meeting its terms? No matter the lender you use, you might be setting yourself up for trouble if you don’t have a plan to repay the loan while meeting its terms. A critical step in understanding which loan is right for you is finding one you can afford.
Know your options
Payday loans can certainly be beneficial under the right circumstances. If you have a sound financial history, but just need a bit of extra cash to cover an expense, a payday loan could be a great option. However, remember that payday loans come with risks, and if you’re not confident in your ability to repay your debt, a payday loan could ruin your credit score, or even land you in court.
Before getting a payday loan, speak with banks and credit unions about your loan options, and find the best rate available. Consider alternative options that might be safer in the long run. Do your research and determine which method is right for you, based on your lifestyle and budget.