Although payday loans can be a lifesaver for those who need quick cash, the high fees charged and short payment terms can cause a cycle of debt.
Payday loans are not defined. However, they are usually a short-term loan of $500 or less. The loan is due on your next payday.
These loans may be marketed as a way to bridge the gap between paychecks or to help with an unexpected expense, but the Consumer Financial Protection Bureau says that payday loans can become “debt traps.”
Here’s why: Many borrowers are unable to afford the loan and fees. So they pay more fees to defer paying back the loan. Or they “roll over” or refinance the debt until they have to pay more fees than the original amount.
Payday loans: What do they mean?
Payday loans may go by different names — cash advance loans, deferred deposit loans, check advance loans or online payday loans — but they typically work and assist you in the same way.
A postdated check, payable to the lender, may be required to obtain a payday advance. You may also authorize the lender to debit your checking accounts electronically. The lender will normally give you cash.
The loan is usually due by the next payday, which can be in between two and four week. If you do not repay the loan plus any finance charges within the due date, the lender will cash your check or debit your bank account.
This type of lending is allowed in many states. However, there are restrictions on how much the loan amount can be borrowed and what fees must be paid. The state may allow companies to charge between $10 and $30 per $100 borrowed.
What are the state regulations for payday loans in your state?
You might be curious about the state laws that regulate payday loans in your area. Keep in mind, however, that not all states allow payday loans.
There is no definitive definition of what constitutes an “payday loan”. Your state may allow other types of short-term personal loans. Check out this chart to see what restrictions apply in your state for what is considered “payday lending”.
Be aware that the APR is not necessarily the same interest charged when you read this chart. For example, a 14 day loan at 10% interest is equivalent to 260.71%.
While payday loans can be a good option for emergency cash, there are some dangers to be aware of.
1. High annual percentage rates
Let’s say you take out a $500 two-week loan with $15 fees per $100 borrowed. The APR for this loan is almost 400% if expressed as an annual percentage. According to the CFPB
A payday loan must be repaid within two to three weeks. Because policies vary, make sure to check your state’s regulations.
You may have to pay additional fees if the loan is not repaid within the timeframe. If you re-borrow or roll the debt over, these fees add up. The CFPB estimates that nearly 25% of initial payday loans are reborrowed nine times.
Additional fees could include…
- Insufficient funds chargesIf you don’t have enough cash in your bank account, lenders may try to cash your check.
- Refund-payment or late feesDon’t pay your loan on due date.
- Rollover feesTo extend the loan’s due date, an additional fee will be added to your original loan.
4. Credit won’t be built
People with bad credit might not be able to get loans with better terms. However, payday lenders won’t report your payment history with the credit bureaus. This can mean that the loan will not help you build credit.
Alternatives to Payday Loans
Although a payday loan may seem like a quick fix for your problem, there are other options to help you stay out of debt. Here are some other options.
Payday loans alternative
A lower-interest personal loan may be available to members of credit unions. Federal credit unions may also offer members payday alternative loans for amounts between $200 and $1,000. These loans are typically available for terms between six and twelve months with a minimum $20 application fee and an APR of not more than 28%.
Some states allow your employer to increase your salary without additional fees. Your company may decide to advance your paycheck without additional fees. Talk to your supervisor or human resources representative about your options.
If you meet certain criteria, you can also try mobile apps like Earnin or Dave. These apps will help you make extra money in between your paychecks.
Settlement of Debt
A debt settlement may affect your credit but could help you resolve your debt and make a fresh start.
Personal loans may come with high interest rates as well, but if you need a loan and don’t qualify for lower rates, it’s important to do some comparison shopping. While you might be eligible for a slightly lower rate or longer term than the storefront payday lender, you won’t find out unless you shop.
A lender who reports to the major credit agencies should be your choice when looking for a loan. If you have a history of making on-time payments, you will be able to build credit and eventually qualify for lower rates.
The long term can be used to address the underlying financial issues that keep you from getting a payday loan. Try credit counseling, which could help you develop a budget, and work on starting a savings account.
Payday loans could be the best option for you if cash is tight.
It’s a good idea to shop around and compare loan options, and consider long-term changes you can make to your finances that might make a difference. To start, you can try creating a budget and making a plan for paying off debt.