The idea of accessing your paycheck before it hits your bank account is appealing, especially in this economy. Unfortunately, there may be a catch.
Payday loans — which are small, unsecured loans that don’t require collateral and have short terms — are a popular way for people to access cash quickly. But in practice, they end up costing borrowers dearly, so you need to know what you’re getting into.
Todd Christensen, education manager at the nonprofit debt relief agency Silver Fit by DRSexplains that payday loans are built around the concept of providing you with just enough money to get to your next payday, which is theoretically within about two weeks.
As such, the loans are very convenient – companies “generally set up their offices more like a fast-food restaurant than a moneylender”, with menu-like posters that spell out fees and requirements.
And just like at McDonald’s, turnaround times are fast.
“The loans are fast, which means you can get the money into your account in an hour or less,” says Christensen. “Compare that to banks and credit unions that will take days or even weeks to approve your personal loan, especially if you have no credit or bad credit.”
The problem with payday loans is that they actually have a high cost. Some lenders will advertise their fees as percentages – but since these rates are based on the (short) term of the loan, they tend to be much worse than they appear. For example, says Christensen, “a 15% fee over two weeks equals an APR of 390% (15% x 26 two-week quarters per year).”
This is not good, especially considering that borrowers who apply for these loans run the risk of not being able to afford repayment.
“Loans are incredibly expensive and cause a whole host of financial consequences and harm,” says Lisa Stifler, director of state policy at the Center for Responsible Credit. “If you’re already struggling to pay your bills on a monthly basis, and you have that loan on top of that in full in a short amount of time…it ends up digging people into more debt.”
Here’s an example of how things can spiral out of control so quickly. Let’s say you take out a $200 payday loan with a $30 fee. But when the end of the two-week period comes, you cannot repay it. So you roll it. You are now responsible for the $200 you borrowed, the first $30, and the additional $30. You only need a few months to owe more in interest/fees that you never had in credit.
Worse still, regulation is patchy at best. In fact, the Consumer Financial Protection Bureau last month canceled a 2017 rule requiring lenders to verify borrowers’ income and expenses before granting them a loan. Stifler says the decision to revoke this “common sense principle” means that “lenders will be able to continue to operate as usual.”
Lenders and online applications are also under scrutiny: As of August 2019, officials in 11 states plus Puerto Rico announcement a survey of the payday advance industry. They are investigating whether tipping mechanisms, monthly subscriptions and other fees “are usurious and harm consumers.”
Conclusion: Payday loans can get into predatory territory if you’re not careful. Be on the lookout for warning phrases like “get money fast,” “same day transfer,” and “no credit checks” in ads, and be careful when borrowing money.
Ideally, you would never run out of money because you would have an emergency fund. But if you find yourself in this situation, Christensen recommends:
- ask a friend for a small, short-term loan and offer to pay the interest
- get a cash advance with my credit card
- consider a personal loan through an online peer-to-peer platform, bank, or credit union
Everyone gets into a tough spot sometimes, but the goal is to find an option with a lower APR (and fewer strings attached) than a payday loan.
“Turning to a payday loan in such cases is a short-term solution that usually ends up making things worse,” he says.
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