The idea of accessing your paycheck before it actually reaches 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 a short duration – are a popular way for people to access cash quickly. But in practice, they end up costing borrowers a lot of money, so you need to know what you’re getting into.
Todd Christensen, education manager at the nonprofit debt relief agency Money Fit by DRS, explains 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 two weeks or so.
As such, the loans are very convenient – businesses generally “organize their offices more like a fast food restaurant than a lender,” with menu-like posters defining fees and requirements.
And just like at McDonald’s, deadlines are tight.
“The loans are quick, 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, if not weeks, to approve your personal loan, especially if you have no credit or bad credit. “
The problem with payday loans is that they actually come at a high cost. Some lenders advertise their fees as a percentage rate, 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% two-week fee equals 390% APR (15% x 26 two-week quarters per year).”
This is not good, especially considering that the borrowers who apply for these loans run the risk of not being able to afford the repayment.
“Loans are incredibly expensive and cause a whole host of financial consequences and harms,” said Lisa Stifler, director of state policy at the Center for Responsible Lending. “If you’re already struggling to pay your bills on a monthly basis, and that loan adds up to it in full in a short period of time… it ends up pushing people into more debt.
Here’s an example of how things can get out of hand so quickly. Suppose you take out a $ 200 payday loan with a $ 30 fee. But when the two week period comes to an end, you can’t pay it back. So you turn it over. Now you have to pay the $ 200 you borrowed, the first $ 30, and an additional $ 30 fee. You only need a few months to owe more in interest / charges that you never had on credit.
Worse yet, 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 “lenders will be able to continue to operate as usual.”
Lenders and online applications are also coming under scrutiny: in August 2019, officials in 11 states and Puerto Rico announcement a survey of the payday advance industry. They are investigating whether tip mechanisms, monthly subscriptions and other fees “are usurious and harm consumers.”
Bottom Line: Payday loans can enter predatory territory if you’re not careful. Look out for warning phrases like “get cash fast”, “same day transfer” and “no credit check” in ads, and be smart when borrowing money.
Ideally, you would never run out of cash just because you 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 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 finds themselves in a difficult situation sometimes, but the goal is to find an option with a lower APR (and fewer terms) than a payday loan.
“Going to a payday loan in such cases is a short-term solution that usually ends up making matters worse,” he says.
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