Avoiding the Payday Loan Cycle
Payday loans are short-term, high interest loans that are very easy to get. It’s convenient to stop at a local cash advance store on the corner if you really want that new TV now…and don’t get paid until next week. But don’t do it! Let me tell you why.
How it works:
The loan process can vary, but usually the borrower writes a post-dated check payable to the lender for the amount borrowed plus fees and interest. The lender may not even verify income or do a credit check. The lender hands over the amount in cash. The lender then holds the check for a period of time, typically two weeks or until the borrower’s next pay day, at which time they will cash the check. If the borrower doesn't have enough in their account to cover the check, the payday loan cycle begins. The borrower must either pay a service charge and write a new check, or take out a new loan to pay off the current one.
Do you ever feel like every time you turn around you see a Starbucks? There are two payday loan locations for every Starbucks. Or, as I like to say, “Two loans for every latte.” About 12 million Americans take out payday loans each year. The lowest interest rate cap for payday loans is 156%, and some states don’t even have a cap.
The average payday loan borrower pays $574 in fees over the course of a year.
So just how expensive is that payday loan?
Say I take out a payday loan for $300 and the fee is $50. I write a post-dated check for $350 and receive $300 in cash today. In two weeks, the lender cashes the check for $350 and we’re done. That’s not bad, right? Maybe it doesn’t seem like it at first glance, but the interest rate on this loan is actually 435%. Most payday loans end up being renewed at least once. Doing so will begin the payday loan cycle and increase the cost and the time to pay off the loan.
If you are in a jam and need funds quickly, this might be a viable way to get through a tough situation. Some credit unions and banks offer short-term loans that are similar to payday loans, but with lower interest rates. So check out your options. Just don’t try to use these loans for everyday living expenses. Staying out of the payday loan cycle will save you a lot of money in the long run.