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Life's curveballs aren't cheap. Whether your alternator gives out or your dog needs an emergency vet visit, there are times when you may need some cash, stat. In an ideal world, you'd swipe your debit card or, in a pinch, your credit card.
This may not be an option for many people, especially those who lack savings and don't have a credit card. Some people in this bind, especially those with bad or no credit, resort to payday loans. They're fast, and have minimal borrowing requirements. But they're heavily regulated, and illegal in some states, due to their very high fees and difficult exit strategy.
What Is a Payday Loan and How Does It Work?
Personal loans from traditional lenders often have minimum amounts in the thousands of dollars and are repaid over months or years. They may also have stringent credit score and income requirements.
Payday loans are short-term loans offered by specialty lenders in small amounts, typically $500 or less, according to the Consumer Financial Protection Bureau (CFPB). The borrowed amount—plus fees—is due in two to four weeks, when the borrower receives their next paycheck. To repay the loan, the borrower either writes a post-dated check for the amount to be deposited after their next payday or gives the lender their bank information to electronically debit the payment.
The appeal of payday loans is instant funding and scant borrowing requirements. While borrowers must demonstrate regular income or employment, credit and existing debts aren't checked. Because of this, payday lenders tend to set up shop in areas populated by low-income workers and communities of color—in other words, areas more vulnerable to predatory lending. Some payday loans are now also available online, increasing ease of access.
Why Are Payday Loans Bad?
On the surface, payday loans might not seem insidious. You have an emergency, you get $300 on the spot, and you have a few weeks to repay. But according to the CFPB, fees are typically $15 per $100, meaning a $300 loan demands a $45 fee—equivalent to an annual percentage rate (APR) of 400%. Data from the Center for Responsible Lending shows that in states with fewer regulations, higher fees mean effective interest rates as high as 500% to 600%. Compare that with credit cards, which currently have an average APR of about 16%.
The term on payday loans is so short that many borrowers can't scrape together enough money to repay on time. Some states allow rollovers, which allow the borrower another term to repay—in exchange for another fee. So that $300 could become $390. Some desperate borrowers take out payday loans continuously when they can't catch up enough to repay the original balance.
What You Should Know About Payday Loans
There are a few key things to understand before you turn to payday loans:
- State rules vary significantly. Some states completely ban payday loans, while others place regulations on the age of the borrow, the amount that can be borrowed, repayment terms and so on.
- The fees add up. In addition to hefty interest rates, payday loans notoriously pile on other fees, such as those for late payment, insufficient funds, returned payment and rollovers.
- It's easy to get stuck. Due to high fees and short terms, borrowers often can't repay on time and have to keep rolling over or taking out new payday loans to cover the last. According to the CFPB, more than 4 in 5 payday loans are reborrowed, with nearly 1 in 4 being reborrowed nine or more times. The fees quickly outpace the original amount borrowed. The CFPB introduced rules requiring lenders to more carefully consider the borrower's ability to repay, but these loans are still problematic.
- They can impact your credit. Payday loans don't appear on credit reports when in good standing. But if you can't pay your payday loan and the account goes into collections, it could wind up on your credit report and hurt your credit scores.
Alternatives to Payday Loans
In desperate times, payday loans may seem like your best option. But due to their risk, consider alternatives first, such as:
- Ask the other party for an extension. Let the business or creditor you owe money to know about your situation, and they just might allow a delayed payment or repayment plan. Depending on the debt, you may be able to seek forbearance or deferment.
- Apply for a traditional loan. While personal loans or unsecured loans are harder to get approved for, some are open to borrowers with bad credit. Make sure to look at credit unions and online lenders, which may be more flexible.
- Request a short-term loan from family or friends. You can offer to pay interest. To avoid conflict, it's wise to get the agreement in writing.
- Get a loan from a peer-to-peer marketplace. Online platforms like Prosper and Peerform match investors with those in search of funds and may provide more affordable options than certain other loan types.
- Find additional income. Earning extra cash could be one way to avoid taking out a payday loan, whether this means pulling extra hours at work, finding a short-term part-time job or getting a side hustle.
- Get a paycheck advance. Ask your employer for an advance on a paycheck. Alternatively, there are also mobile apps that advance money for a fee.
- Consider consolidating your payday loans. If you've already taken out payday loans and are trying to break the cycle, consider consolidating your payday loans with a personal loan at a lower interest rate.
The Bottom Line
When you're in a financial jam, it's understandable to consider a payday loan. Just remember that the fast, easy money comes at a high cost that you may be able to avoid by seeking other options. Unless you're able to repay the loan and its fees as soon as they're due, you may find yourself stuck in a debt trap.
If your credit isn't stellar, try using Experian CreditMatch™ to see if you can get approved for a credit card for bad credit that you commit to use only for emergencies. These may offer better terms and be less risky than a payday loan.