What You Should Know About Payday Loans
Flashy online ads and brick and mortar storefronts promising quick cash to anyone have become all too popular across the U.S. If the thought of a quick cash infusion has you thinking “should I get a payday loan?” you may want to reconsider.
Understanding why payday loans are bad and the effects they can have on your long-term financial picture is critical to making an informed borrowing decision.
Why you should avoid payday loans
Payday loans are a form of short-term borrowing where you’ll get a lump sum of money that is due upon your next paycheck. In a sense, it’s an advance on your next paycheck, usually two to four weeks out. While this might sound like a good deal, there are plenty of reasons you should avoid payday loans.
They’re incredibly expensive
While quick money can be attractive, it’s also expensive. How expensive? The average premium you’ll pay on a two to a four-week payday loan is between $10 and $30 for every $100 borrowed. The Consumer Financial Protection Bureau states that “A typical two-week payday loan with a $15 per $100 fee equates to an annual percentage rate (APR) of almost 400 percent.”
However, it’s not only associated fees that can make a payday loan expensive.
“There are many different reasons you should avoid a payday loan as much as possible. For starters, these usually come with extremely high interest rates, which can cost you much more than what you initially borrowed,” says Sacha Ferrandi, founder and principal of Texas Hard Money and Source Capital Funding. “Payday loans can easily add more debt to your name and fast with all their extra fees that you would have to pay, especially if you do not pay on time.”
Payday loans breed a cycle of debt
A major problem with payday loans is they tend to reinforce bad financial habits and breed a cycle of debt that can become harder and harder to break. If you’re unable to pay off your first payday loan, you might be tempted to renew the loan or take out an additional loan. You’ll end up being several paychecks behind, and without more income, you may never get out from under the cycle.
“Avoid payday loans as much as you can for your financial security,” adds Ferrandi.
Payday loan alternatives
Using a payday loan should be your absolute last resort. If you need quick cash, there are better options you can use before tapping into financially risky payday loans.
Utilize a credit card
Credit cards are an option for a short-term infusion of cash. While they are still an expensive form of lending, they are nowhere near as expensive as payday loans. The average annual percentage rate (APR) on credit cards is around 14% to 20%. Again, this rate is for the entire year, not just for a few weeks. At the end of the day, you’ll need to find a solution to spend less than you’re bringing in, or you’ll end up in a perpetual debt cycle. But if you need some quick assistance that’s part of your recovery plan, a credit card is a viable option.
Take out a personal loan
A much more structured form of borrowing that you may be able to get is a personal loan. Personal loans are often unsecured — meaning you don’t need collateral to get approved — and can offer rates anywhere from around 5% up to around 25%. Again, these rates are for the entire year and not just for a few weeks.
Additionally, personal loans don’t require you to pay back the full loan within a couple of weeks. Personal loans can extend out several years, which may give you the financial flexibility you need..
While you may think that less-than-great credit makes you unable to get a personal loan, many lenders offer services to customers with poor credit. Yes, you may end up paying a higher rate, but it will be much lower that of a payday loan, and there’s more time to make good on your borrowing promise.
Payday Alternative Loans (PALs)
The National Credit Union Administration (NCUA) gives federal credit unions the ability to offer small-dollar loans at significantly lower rates and fees than a payday loan. Currently, there are two versions of PAL loans available: PAL I and PAL II. PAL I loans can be from $200 to $1,000, have loan terms of one to six months, and have a maximum APR of 28%. On the other hand, PAL II loans have no minimum and cap out at $2,000. Loan terms are between one month and one year, and also have a maximum APR of 28%. It’s important to note that APR rates include all fees.
To take out a PAL I loan, you would need to be a member of a credit union for at least one month. For PAL II, this restriction does not exist. PAL loans are a much more effective source of financing for those that have exhausted all other available options.
Finding yourself short on cash in an emergency is a pressing situation. Most likely, if you’re looking at payday loans, you’re feeling pressure to meet an important financial obligation. Before you go out and sign up for a payday loan, though, make sure you have exhausted all your other options. Most people will find they can meet their financial needs with credit cards, personal loans, or a Payday Alternative Loan through a federal credit union.