Steer Clear of Payday Loans
When you're recovering from bankruptcy or trying to stay out of debt, you may find that money gets tight from time to time. And when cash runs short, you may be tempted by short-term financial "solutions" like payday loans to help you out of a tight spot.
Unfortunately, it's often these so-called solutions that push struggling consumers over the edge and into bankruptcy or unmanageable debt.
Payday loans (also known as cash advance loans and checkbook loans) are one of the most dangerous sources of credit for those struggling to stay out of debt – unfortunately, they may seem like the only choice left.
Understanding Payday Loans
To get an idea of why payday loans can be so exorbitantly costly to borrowers, it's important to understand how they operate. Here's what you could expect from a typical payday lender in theory:
- You write a check to the payday lender for the amount of money you want to borrow PLUS a certain fee. Most lenders charge between $15 and $30 for every $100 borrowed, so let's say you wanted to borrow $300 and the store charged $25 per $100 borrowed. You'd write a check for $375, postdated to your next payday.
- The payday loan store gives you $300 cash and agrees to hold on to your check until you next get paid.
- When payday rolls around, you redeem the check by returning to the payday lender and paying $375 in cash.
Theoretically, you've paid $75 dollars for the privilege of using $300 for a period of a week or two – perhaps not the best investment, but not terribly harmful if you only need to use the service once.
People who take out payday loans often expect that they'll only need the services one time, but in practice, that's rarely the case.
When you're short on cash to begin with, unexpected expenses tend to eat away at what little you have. In the real world, payday loans often work more like this:
- You write a check for $375 and get $300 in cash.
- When payday comes, you've got other expenses you didn't expect, and aren't able to repay the full $375.
- You pay only the interest on your loan ($75), which allows you to "roll over" your loan until next payday.
- When payday comes again, you still owe $375, despite your previous $75 payment. If you're unable to cover the full amount, you can again "roll over" the loan for another pay period, for another payment of $75.
- Most payday lenders have a limit to how many times you can roll a loan over; once you hit that limit, the lender will attempt to deposit the original $375 check you wrote. If you don't have money in your account to cover the check, it will be returned, and you'll likely face bank fees in addition to the payday loan. Plus, the lender will probably start collection actions such as:
- Turning your case over to the corporate office to handle
- Attempting to deposit the check over and over (which can lead to serious bank fees charged to you)
- Filing a lawsuit against you, meaning you'd be responsible for court and lawyer fees as well as the original check amount
- If you're able to pay the check in full, you can. But, you've already paid hundreds of dollars in interest and fees and, because of this drain to your cash flow, you may find yourself in need of taking out another payday loan in the near future, thus starting the cycle again.
When viewed from this angle, the dangers of payday loans are more evident.
Unfortunately, when more traditional sources of credit (including banks and credit unions) are unwilling to lend you money because of a weak credit report, you may feel as if you have no place to turn other than a payday lender.
The Good News
The good news in all of this is that lawmakers and major government institutions are starting to pay attention to payday lenders and the financial damage they can inflict on consumers.
The FDIC has investigated the payday lending industry and the Federal Trade Commission (FTC) has posted useful information on payday loans.
But regulation takes time to pass into law, and meanwhile, new payday lenders seem to be cropping up and hiking their interest rates across the nation.
So, what should you do if you need money and don't have stellar credit? Consider some alternatives to payday loans.
Payday Loan Alternatives
Some credit counselors have even recommended credit card cash advances over payday loans, which is a serious indictment: credit card advances are generally considered pretty expensive credit in their own right. But here are some other options you may have to avoid payday loans:
- borrowing from a credit union
- borrowing from friends or family
- asking for a payroll advance from your employer
- visiting an online peer-to-peer lending site
- borrowing from a small loan company
- taking out a credit card cash advance
- negotiating with creditors for extended time to pay
- using overdraft protection on your checking account
Take charge of your financial future: learn as much as you can about high-interest credit like payday loans and abusive overdraft loans from banks.