SmartipediaWhat are the risks of payday loans?
The Dangerous Allure of Payday Loans
Ever find yourself a little short on cash before payday? You’re not alone – millions of Americans turn to payday loans every year to bridge that gap. But these short-term loans can quickly become a long-term debt trap. Let’s dive into the risks of payday loans and why you might want to explore other options.
What Are Payday Loans?
A payday loan is a small, short-term loan that you typically have to repay with your next paycheck. It’s called a “payday” loan because the due date is usually your next payday. To get one, you give the lender a post-dated check for the loan amount plus fees, and they give you cash. On your next payday, the lender cashes that check.
It sounds simple enough, right? But here’s where things get tricky…
The Trap of High Fees and Rollover Loans
Payday loans come with exorbitantly high fees – we’re talking triple-digit annual percentage rates (APRs)! For example, a two-week $300 loan with a $45 fee has an APR of nearly 400%. Yikes!
And if you can’t repay the full amount on your next payday, you’ll likely have to “rollover” the loan and pay additional fees. This is how many borrowers get caught in a cycle of debt, paying fees upon fees just to delay repayment.
Surprising Fact: The average payday loan borrower is in debt for nearly half the year.
The Domino Effect
Payday loans can quickly spiral out of control and wreak havoc on your finances:
Overdraft Fees: If the lender tries to cash your post-dated check and you don’t have enough in your account, you’ll get hit with overdraft fees from your bank.
Damaged Credit: Defaulting on a payday loan can tank your credit score, making it harder to get affordable credit in the future.
Bank Account Closure: Some lenders may attempt to collect by repeatedly trying to cash your check, leading your bank to close your account.
Surprising Fact: Over 80% of payday loans are rolled over or renewed within two weeks.
Alternatives to Consider
Before taking out a payday loan, explore these options:
- Ask your employer for a paycheck advance
- Borrow from friends or family
- Get a side gig or sell some belongings
- Contact creditors to request an extension or payment plan
- Look into personal loans or credit counseling
Surprising Fact: Payday loan usage is higher in communities of color and low-income neighborhoods.
Learn More
- Debt Consolidation: Combining multiple debts into one loan with a lower interest rate.
- Credit Counseling: Working with a professional to develop a debt management plan.
- Budgeting Basics: Strategies for managing your money and avoiding debt traps.
The bottom line? Payday loans should be an absolute last resort. Explore all other options first to avoid the vicious cycle of debt.