You’ve probably seen places that offer payday loans, but if you’ve never gone into one of these businesses, you may have no idea what they’re talking about. Basically, a payday loan is a cash advance, albeit a very expensive one. You can get cash equal to all or a portion of your pay check in advance, and all you have to do is repay the loan plus interest by your next payday. While most people do not need this service, anyone who finds themselves running low on money may decide to take the risk of falling into a payday loan trap.
What kind of trap is that? Well, to get your payday loan, you have to write a personal check for the total amount. If you don’t pay the loan back, the business cashes that check. Chances are you didn’t pay back the loan because you didn’t have the money. This means your bank account will be overdrawn when the business cashes the check. To avoid this, many simply borrow money to pay back the loan, then immediately take out another loan to pay back the borrowed money. Thus, they become trapped in a cycle of borrowing and paying off the payday loan. Each time they pay back the loan, the loan company gets a percentage of the paycheck as interest, which only makes it more difficult to pay it off.
This is how payday loan companies make their money—they either take a portion of your check as their interest or they add a processing fee on to the transaction (sometimes both!). By setting high interest rates and difficult-to-make repayment schedules, they can trap a person into constantly taking payday advances, which makes them more and more money.
Why would people do this? Well, some simply find themselves strapped for cash, especially when the economy is down. Others find themselves out of work and, using their last paycheck, get an advance that they can’t repay. Still others find themselves unable to pay their home loan, auto loan, or other financial obligation, so they get a payday loan thinking it will be a one-time thing. Then they discover that, after paying off their mortgage or other loan, they don’t have enough money to pay back the payday loan.
To get a payday loan, all you need is a bank account, a steady income, and a form of identification. Lenders generally do not conduct any sort of credit check or make you apply. Some do not even continue to check if you have a job—it is actually possible to continue to get a payday loan after you’ve lost your job: just as long as you can continue to somehow repay one loan, you can take out another. You can get a payday loan from a check cashing business, a loan store, and even from some pawn shops and rent-to-own businesses. Some loans can also be made online and over the phone. For these last two options, you may have to give the loan company access to your online banking account.
When it comes to loan terms, a payday loan is usually between a hundred and a thousand dollars. Some states do have set maximums that determine how large of a payday loan you can get. Generally, these loans are due in two weeks. The annual interest is, on average, a whopping 470%, although the APR can be anywhere between 400% and upwards of 750%. Longer loans actually have higher APRs so the company can still make a good amount of money. The finance charges also vary, usually by the amount of money you borrow. For $100, your finance charge will probably be around $20.
When compared to other forms of loans, payday loans are, obviously, much more expensive. If you are in need of emergency funds, asking your employer for a small paycheck advance is often preferable. If that’s not an option, getting a cash advance from a credit card may be cheaper, although they often feature very high interest rates as well.
With all of this talk of traps and high rates, you may think that payday loans are some kind of a scam. Well, the truth is that they are legitimate businesses recognized by laws in 35 different states, although some people feel they should not be. Because of the high potential of bankrupting people, many states have passed laws regarding payday loans. Eleven of the states that recognize payday lending have laws that set payday interest rate caps. However, in at least one state (Arkansas), these laws have been declared unconstitutional on the grounds that the government was interfering in private business. If you’re going to look into getting a payday loan, you should look into what laws are in effect in your state.
Starting in October of 2007, some federal guidelines went into effect for military personnel and their families. These laws state that no payday loan, car loan, or tax refund loan could charge military families more than 36% interest.
There are many risks when it comes to using a payday loan business. You most likely do not have the funds to cover the personal check you use to secure a payday loan, meaning you risk bank overdraft charges if you can’t pay back the loan. This can also affect your credit score, make it difficult to open a new bank account in the future, and may even result in bankruptcy if you’re not careful. If your personal check bounces, the payday loan company may even be within their legal rights to sue you for even more money, putting you further in debt.
Because of these risks, it’s very important that you weigh all the pros and cons before you get a payday loan. While they can help you out in a tough situation, if you’re not very careful, you may end up simply making your financial situation worse.