When you’re short on cash in between paychecks or have an unexpected financial emergency, a payday loan can be a tempting option to help make ends meet or access money quickly. However, these short-term loans, which are typically due on your next payday, are extremely risky. They come with very steep interest rates and other fees. The interest rate on payday loans across the United States ranges from 154 percent to as high as 664 percent or more.
Equally troubling, payday loans are often marketed to those who can least afford them— individuals earning less than $40,000 annually. While this type of lending is advertised as a short-term loan, payday loans can create a cycle of debt that’s difficult to break free from.
What is a payday loan?
A payday loan is typically a short-term loan, lasting anywhere from two to four weeks, that does not require collateral to obtain. These types of loans are usually expected to be repaid in a single payment with your next paycheck, when you receive income from Social Security or when you get a pension payment.
In the majority of cases, payday loans are granted for relatively small amounts, often $500 or less, with the average borrower obtaining a payday loan for about $375. In some cases, payday loans can be made for larger amounts.
To get a payday loan, borrowers are asked to write a personal check for the amount of the debt plus any finance charges and fees. If the loan is not paid back on time, the lender will deposit the check to recoup their funds. Some lenders may ask for authorization to electronically deduct the funds from your bank account instead of requiring that you provide a personal check.
Payday loans generally do not involve credit checks and your ability to pay back the debt while also continuing to pay your everyday expenses is typically not considered as part of the application process.
Who usually takes out a payday loan?
Payday loans are most commonly sought out by those who have ongoing cash flow challenges, as opposed to borrowers who find themselves facing a financial emergency. A study of payday loans conducted by the Pew Charitable Trusts found that the vast majority of payday loan users, 69 percent, first resorted to this type of borrowing to cover recurring expenses such as utility bills, rent, mortgages, student loan payments or credit card bills. Just 16 percent of borrowers use payday loans for unexpected expenses.
These types of loans are also widely used by individuals living in neighborhoods and communities that are underserved by traditional banks or by those who do not have a bank account with a major financial institution. There are about 23,000 payday lenders across the country, many located in storefronts or operating online.
What are the risks of payday loans?
Because of the many risks associated with payday loans, they are often considered predatory lending.
To begin with, payday loans often come with astronomical interest rates. Those who take such loans are required to pay anywhere from $10 to $30 for every $100 borrowed. A typical payday loan with a two-week repayment timeline and a fee of $15 per $100 equates to an APR of nearly 400 percent.
Many payday lenders also offer rollovers or renewals, which allow you to simply pay the fees for borrowing the money on the loan’s due date and extend the balance due for a longer period of time. This can be a slippery slope that causes borrowers to quickly get in over their head with accumulating fees and interest. Borrowers default on as many as one in five payday loans, according to the Consumer Financial Protection Bureau.
What’s more, because payday loans do not consider an applicant’s full financial picture, including their ability to keep up with other financial obligations and living expenses while repaying the payday loan, this type of loan often leaves borrowers in a vicious cycle of debt.
Are payday loans ever worth it?
With their steep interest rates and fees, a payday loan is rarely a good idea. The fees alone cost Americans $4 billion a year. Because the costs associated with these loans are so high, borrowers often struggle to repay them and get into deeper debt, making it a good idea to consider your options carefully before taking on a payday loan.
However, if you have an urgent need, or require cash quickly and are absolutely certain you’ll be able to pay the loan back with your next paycheck, then a payday loan may make sense. These loans may also be worth considering if you have no other financial options or if you have poor credit and would not qualify for a traditional loan.
Alternatives to payday loans
Before taking on the significant financial risks associated with a payday loan, investigate other alternatives that may be less costly. Some of the options to consider include:
- Personal loan: For those who have a good credit score, a personal loan can be a safer and more cost-effective option for borrowing. What’s more, if you need cash quickly, there are online lenders that can provide personal loan funds in as little as a day or two.
- Borrowing money from family or friends: Payday loans should be a last resort. If you have family or friends who are willing to help, it can be a better idea to borrow money from loved ones rather than a predatory lender.
- Home equity loan: Tapping into your home equity will offer a far more competitive interest rate than a payday loan. Home equity loans are a popular way to access cash to consolidate debt or pay for other major or unexpected expenses. In order to access your home’s equity, however, you’ll need to meet certain requirements, including having a good credit score, steady income and a debt-to-income ratio of 43 percent or less.