Simply put, Payday loans are loans that you apply for in case of a sudden unplanned charge which your paycheck falls short of covering. This is typically against your paycheck as you pay the loan back when the next salary follows through. These are short term loans that you apply for by way of a personal check but at high rates of interest.
Imagine this- your month was going smoothly when suddenly an appliance breaks down. It costs you an arm and a leg to repair it. You already spent a fat amount of your salary on fancy restaurants and this is the end of the month. What do you do? The easiest and most tempting solution that financial institutions offer- payday loans.
You go to the bank or apply for payday loans online. Most common essential requirements are- your basic information like your name, your address, your contact details, your checking account details, your social security number, documentation of your income, the requested amount and that’s it! The approval for a payday loan comes almost immediately as it does not involve the traditional credit check. It, therefore, also has no bearing on your credit score.
Yes, this looks yea, so simple and your rescuer in times of trouble. But like life, most good things come with downsides. Here are some of the major ones that accompany a payday loan:
Sky Rocketing Costs
Payday loans, being short term loans are oftentimes way more expensive than most traditional loans. The Consumer Financial Protection Bureau (CFPB), a US financial regulatory body reported in June 2017 that “the amount of the fee for a payday loan may range from $10 to $30 for every $100 borrowed depending on the state law. A fee of $ 15 per $100 is common, it states which equates to an Annual Percentage Rate (APR) of almost 400% for a two-week loan. So, for example, if you need to borrow $300 before your next payday, it would cost you $345 to pay it back, assuming a fee of $15 per $100”- higher than what traditional loans will cost you.
The Rollover Trap
The starting point of this spiralling trap is when you find yourself unable to pay back the loan within the designated two-week window. The lender typically suggests you pay whatever amount you can now and roll the rest of the amount over to the next month, but, and here’s the catch- at an additional cost. This additional cost is the real culprit. CFPB elucidates- “Using the above example if you pay a renewal or rollover fee of $45 you would still owe the original $300 loan and another $45 fee when the extension is over. That’s a $90 charge for borrowing $300 for just four weeks.”
A Reflection On Your Credit Score
In case you fail to repay the loan after repeated rollovers, the lender might transfer your case to a collection agency who may, in turn, report the non-payment of the loan to bureaus which may negatively impact your credit score. Moreover, credit scores are affected indirectly in general as payday loans reflect on the borrower’s ability and propensity towards their financial obligations.
What Are The Alternatives?
Getting a personal loan could always work out to be easier on the borrower’s capability to pay over a long period with interest rates working out to be much lower in the long run as compared to those of the payday loans. Then there are some negotiation skills that can come in handy in a tight financial position. Given your inability to clear urgent bills, you’ll be surprised to know that a lot of companies are willing to provide extensions if you explain your situation. Also, you may even speak to your boss at work for an advance on your salary which can go a long way in meeting emergency unpredictable financial crises.
From the field of Behavioural Economics, there is an important point that surfaces. In their research paper published in 2011, Bertrand and Morse provide survey evidence “that even if payday borrowers expect to renew the loan several times, they tend to get the math wrong. That is, survey respondents typically did not correctly add-up (and, more importantly, underestimated) the fees stemming from multiple renewals”. Hence this seems to be a well-planned trap that the lenders estimated and even expected at the cost of exacerbating perpetual liquidity problems for the borrowers.
For reasons of such high rates of interest and the vicious cycle of rollovers, payday loans have met with a lot of criticism from all quarters and some even go so far as to say that it’s a profit-driven exercise which takes advantage of the incapability of persons in weak financial situations. Keeping this in mind, one can go ahead with a payday loan only if one is a 100% confident in their ability to pay it back.