“Get more than $1,000 in the bank today!” the ads promise. “Need cash now? Get approved in seconds!” others claim. Most people have felt the financial squeeze that comes in the days before their next paycheck, so these offers start to sound attractive. After all, it basically gives you your paycheck a few days early for just a small fee – right?
In fact, payday loans (or deferred deposit services) are some of the most dangerous loans around. They provide instant, easy loans, but the price is incredibly high and the habit can be hard to break. If you are ever tempted by a payday loan, tighten your belt and wait until your next paycheck. It will be worth it, every time.
What’s a Payday Loan, Really?
Payday loans are debts issued using a future paycheck as collateral. You write a postdated check to the lender for the entire loan, plus the loan fee, and the lender gives you cash – typically no more than $1,000 to $1,500, but frequently only a couple hundred dollars. The loan is very short term, usually only two weeks long. Then you either bring cash to the lender and “buy” back the check, start on a simple payment plan, or the lender cashes your check, now correctly dated, and it is automatically paid.
The Hits Keep Coming
The key and trap of payday loans is the charge for the loan, which usually works out to $15 to $20 for every $100 you borrow. The math is easy: You are in debt with a 15 to 20 percent interest rate for the two week period. That works out to an annual percentage rate between 390 to 780 percent, laughable numbers for any traditional loan.
This means that if you do not pay the entire loan off immediately, the payment plan becomes treacherous. You can rollover the loan to another period, with additional charges and interest rates, but once you start rolling over it is difficult to stop. Imagine the charge is $15 for every $100, and you need $200 right away. You pay $30, receive your $200, and use it…but then in a couple weeks the next payday comes around and you are strapped for cash again. The lender gladly lets you rollover the loan, charging you another $30 on top of the $200 that you still owe. A month later, after several more rollovers, you have paid the lender $180…and still owe $200, plus the check cashing fees the lender will charge you. This is not a theoretical scenario – Americans fall for such scams every day, often with interest rates far worse than 15 percent.
The Payday Loan Market
With such awful terms, you may wonder why payday loans work at all. Business continues because of misinformation and desperation, along with the rise of Internet-based scams that often ignore state laws. People short on cash rarely stop to do the math. They simply accept the loan and mentally assign their next paycheck to paying it off. But that mental control slips after only a few days, and the cycle begins. One problem is that people are only seeing the charge for a single term, when it does not look so harmful. A second problem is the infinite number of ways to spend a paycheck before that loan comes due. All it takes is a little loss of self control.
If you still find yourself needing the money, there are several alternatives to payday loans. More practical, debt-free options including simply working overtime to build up a cash reserve, making money through a supplemental activity, or creating a budget and sticking to it. However, there are also a number of small loans and nonprofit assistance programs that can help you if you simply do not have the time or financial experience. The good news is that nearly any type of loan, including a bill float program, is more favorable than a payday loan. The bad news is you may have to ask your boss for a payday advance, or seek out credit counseling to create a better lifestyle plan. In the long run, even these options will save you significant hassle compared to the dangerous trap of payday loans.