How payday loans work
Say you need cash quickly and are thinking about taking out a personal loan.
Your electricity has been cut for non-payment or your car has blown a joint. Your savings account is empty and you think your credit rating is too low to qualify for a bank loan. You won’t get paid for 10 days and decide to take out a payday loan to help you out.
If you live in a state that allows payday lenders, you can visit a physical location or go online. Payday lenders make it easy for you. All you need is your ID, a pay stub (or other proof of employment), and a post-dated check. You tell the lender how much money you want, write a check that covers the loan and fees, and post-date the check by two weeks.
If, like most borrowers, you are unable to repay the loan when due, you may need to take out another payday loan to cover the first one. Every time you take out a new loan, interest charges and fees add up, making it harder to take out debt. Worse yet, a personal loan study by The Ascent found that you could end up paying 400% or more in interest and fees. To put this in context, the average credit card interest rate is around 15%.
Suppose you borrow $ 500 for 14 days and the APR reaches 400%. On day 14, when the loan is due to be repaid, you owe the original $ 500 plus $ 77 in interest. Quite often people cannot pay off the full $ 577 and are forced to take out another payday loan. You would then start paying interest on the interest.
If you currently owe money on a payday loan, this situation will be all too familiar to you. As difficult as it may sound, the sooner you can break the cycle, the better. Here are four steps that might help:
1. Talk to a nonprofit credit counseling agency
Credit counselors won’t lend you money, but they will help you take control of your personal finances by making a plan to pay off debt, cut unnecessary spending, and get the most out of your money. Look for a certified advisor, check their qualifications, and make sure you understand the costs involved. Many reputable nonprofit credit counseling organizations offer free help.
2. Consider payday loan alternatives
There are a number of payday loan alternatives that you can try.
A personal loan from a reputable lender could help you pay off the payday loan in full. Don’t assume that you can’t get a short-term loan from a bank or credit union just because your credit is good or bad.
Opt for a personal loan with guarantee. This is a type of secured loan that requires you to provide something of value that the lender can take if you don’t pay off the loan, like your car title – but be aware that if you fall behind payments, you risk losing your transport.
Using your car as collateral through a reputable financial institution should not be confused with “title loans” available from predatory lenders. Title loans are no better than payday loans and will cost you just as much.
3. Check with churches and community organizations
There are a number of charities, including churches and community groups, that could help you get back on your feet. Your state may also have hardship programs available. Ask for as much help as you can and invest the extra money in this payday loan.
For example, you could do your grocery shopping in a pantry or accept help paying your electric bill. You can then use your grocery and electricity money to pay off the high interest loan.
4. Consider a cash advance
This might be the only time in your life when someone suggests that you take out a cash advance with a credit card. If you are in a real rush, it is better to pay 30% APR on a cash advance than 400% APR on a payday loan. Cash advances usually come with a fee and start earning interest immediately, so you’ll still need to repay them as soon as possible. The last thing you want is to find yourself stuck in a cycle of high interest credit card debt.
Whichever way you choose to repay the payday lender, you can escape. And when you do, you’ll need to make a plan to make sure it doesn’t happen again. It can mean taking a sideways turn that keeps you on top of your bills. This may involve ruthlessly reducing all expenses, except necessary expenses, from your monthly budget until you have an emergency fund that will get you through a crisis. You might be able to share the expenses by taking a roommate, use public transportation to sell your car, or find cheaper accommodation.
Whichever route you choose, you can be sure that it is better to take out another payday loan. Like casinos, payday lenders always win, but only if you gamble.