Payday loans are expensive and charge very high fees which must be repaid within a short period of time. In fact, you could end up paying an effective APR over 400% if you take out a payday loan.
Despite this disadvantage, many people use payday loans anyway. And there are valid reasons for this. Occasionally, not having the money that a payday loan can provide could have worse consequences than paying the loan fees. For example, if a payday loan saves you foreclosure or repossession of your vehicle and that was your only option, then taking out the loan might have been a good decision.
But while there are certain circumstances where you can justify paying high fees to borrow by this method, it’s important to keep in mind that it’s not the one-time fees that make payday loans so dangerous. It’s the vicious cycle that forces you to keep borrowing more and more money. Read on to find out more.
One Email a Day Could Save You Thousands
Expert tips and tricks delivered straight to your inbox that could help save you thousands of dollars. Register now for free access to our Personal Finance Boot Camp.
By submitting your email address, you consent to our sending you money advice as well as products and services which we believe may be of interest to you. You can unsubscribe anytime. Please read our privacy statement and terms and conditions.
The Payday Debt Cycle
The major problem with payday loans is that you have very little time to pay off the full amount you owe. In fact, you usually only have a few weeks at most to get the full value of the loan. We are far from traditional personal loans, which you can repay over several years.
Unfortunately, if you’ve been forced to take out a payday loan, chances are you are already financially out of breath. Taking out this type of loan means that you are committing on future salary to making a large lump sum payment, which is likely to cause you a lot more problems.
Once payday arrives, you may not have enough money to cover the full cost of the loan so soon. This is especially true for people who haven’t had much time to recover from the financial crisis that caused them to need the payday loan in the first place.
If you can’t cover the loan, you may have to borrow again – and pay a second costly fees. People who use payday loans usually keep falling further and further behind this way, with the costs amounting to a fortune.
Even if you can paying off the loan right away will likely eat away at a sizable enough portion of your check. When this happens, you could soon find yourself running out of funds shortly thereafter and thus take out another payday loan. Plus, it means paying the high fees a second time – and maybe a third, fourth, and so on.
Basically the problem comes down to the fact that you are committing future income to cover a current crisis, plus payday loan fees. This increases the likelihood that you will be trapped in an ongoing cycle of costly debt. This is why the Consumer Financial Protection Bureau discovered that most short-term loans end with a re-borrowing chain of at least ten ready.
What can you do to prevent this cycle?
Ideally, you will be able to avoid payday loans so that you don’t find yourself trapped in this cycle. You can prepare for it by saving an emergency fund. Your tax refund or stimulus checks could serve as a starting point for this fund and give you at least some cash for surprise expenses.
If you can not save an emergency fund, then explore other options such as alternative payday loans from credit unions. Compared to a payday loan, these come with lower fees and longer repayment periods.
But if you have to take out a payday loan, do everything you can to avoid borrowing again, even if you have to work in parallel or reduce your expenses before the repayment deadline is due. This way you can avoid getting into more debt.
You can also look for government resources that could help you deal with a financial crisis. And if you find yourself in a cycle of borrowing, know that you are not alone, you are one of the many trapped in a vicious cycle. For more resources and ideas to help you avoid payday loans, check out our guide on how to pay off your debt.