If you don’t know what a payday loan is, be grateful. A payday loan is essentially an advance on your paycheck; the loan is provided by a third-party. Some people might think that these loans are sent from heaven above, but are they really a good thing?
Payday loan companies are the legal, modern day versions of loan sharks.
The interest on these loans is frequently over 100%. No one wants to be on the wrong side of that kind of an interest rate.
How Payday Loan Works
Let’s suppose you needed some money and couldn’t wait until your next paycheck. You could simply stroll into your local Payday Loan location and apply for a loan. They will verify your income, and then you would write a post-dated check for the amount of the loan, interest, and fees. When you get paid, the check that you gave them is cashed.
The amount of the loans is typically from $50 to $1,000, largely depending on your income. The interest rates are typically in the 200% to 500% range (annualized). While charging this amount of interest is illegal, companies are able to get around the laws by referring to the interest as a “service fee.”
Where’s the Law?
It’s already been mentioned that these companies get around the usury (interest) laws by charging service fees. Many states have exemptions for loans made by foreign companies or companies formed in another state. In those states that won’t allow the high “service fees,” companies will take advantage of these exemptions.
So a company in one state can make a loan to a person in another state and avoid breaking the law. This allows these companies to operate essentially anywhere.
Payday loan lenders frequently have questionable ethics and are a common source of complaints. Fraud and identity theft are commonplace, so be sure to look into whom you’re giving your post-dated check and your personal information.
The Main Issue
Payday loans are rarely a one-shot deal. The people that typically make use of these loans are typically lower income folks with challenging credit. After they deal with the cost of one payday loan, they are just that much further behind with the next paycheck. This leads to another payday loan. It really is a case of “two steps forward, three steps back.”
This cycle of dependency can be difficult to break once it gets started. As these loans continue to be more common, more payday loan companies are reporting to the credit bureaus. People that utilize these loans frequently have credit challenges already; another ding on their credit report can be very damaging.
While no one wants to borrow from friends and family, almost anything is better than a payday loan. A personal loan from a bank is another alternative, though not always easy to accomplish. Consider selling some of your personal items on Craigslist, eBay, or have a garage sale.
Do everything you can to avoid the Payday loan outfits; you’re financial health depends on it.
Payday loans should always be your last resort, but sometimes it may be the only resort. If you do have to get a payday loan, ask around and get an opinion about the various companies. Be sure to compare the loan terms between different lenders.
Payday loans not only charge outrageous interest / fees, they foster dependence that can be difficult to break. They can also create a situation that harms your credit and exposes you to potential fraud.
Now would also be a good time to start your emergency fund; the next time you have a financial hiccup, you’ll be ready.