How payday loans work
Let’s say you need money fast and you’re considering taking out a personal loan.
Your electricity was cut off for non-payment, or your car blew a joint. Your savings account is empty and you think your credit score 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 get by.
If you live in a state that allows payday lenders, you can go to a physical location or go online. Payday lenders make it easy. All you need is 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 postdate the check 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 get out of debt. Worse still, a personal loan study by The Ascent found that you could end up paying 400% or more in interest and fees. To put this into 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, you owe the original $500 plus $77 in interest. Quite often people cannot repay the full $577 and are forced to take out another payday loan. You will 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 seem, the sooner you can break the cycle, the better. Here are four steps that might help:
1. Talk to a non-profit credit counseling agency
Credit counselors won’t lend you money, but they’ll help you take control of your personal finances by developing a plan to pay off debt, cut unnecessary expenses, and get the most out of your money. Look for a certified counselor, check their qualifications and make sure you fully understand the costs involved. Many reputable non-profit credit counseling organizations offer free help.
Speaking of nonprofits: Here’s The Ascent’s list of the best credit cards for nonprofits.
2. Consider payday loan alternatives
There are a number of payday loan alternatives that you may be able to try.
A personal loan from a reputable lender could help you repay the payday loan in full. Don’t assume you can’t get a short-term loan from a bank or credit union just because you have fair or bad credit.
Find out about a personal loan with collateral. This is a type of secured loan that requires you to provide something of value that the lender can take if you don’t repay the loan, such as the title to your car – but be aware that if you fall behind on your payments, you risk losing your transportation.
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 possible and invest the extra money in this payday loan.
For example, you might shop at a food pantry or accept help paying your electricity bill. You can then use the money from your groceries and electricity to pay off the high-interest loan.
4. Consider a cash advance
It might be the only time in your life that someone suggests you take out a credit card cash advance. If you’re really in a hurry, it’s 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 always want to pay them back as soon as possible. The last thing you want is to get stuck in a cycle of high interest credit card debt.
No matter how you choose to repay the payday lender, you box escape. And when you do, you’ll need to come up with a plan to make sure it doesn’t happen again. It can mean taking a scramble that keeps you on top of your bills. This may involve ruthlessly cutting all but necessary expenses from your monthly budget until you have an emergency fund to get you through a crisis. You might be able to split the expenses by taking a roommate, using public transportation to sell your car, or finding cheaper housing.
Whichever route you choose, you can be sure it’s better than taking out another payday loan. Like casinos, payday lenders always win, but only if you play.