Payday loans are often marketed as quick, easy solutions to financial hardships. 12 million Americans take out payday loans every year, according to The Pew Charitable Trusts.
However, payday loans can come with serious risks and financial burdens that can leave borrowers in worse shape than before. While these loans may be easy to access, their high costs and short repayment periods can create a cycle of debt.
If you’re considering a payday loan, here’s what you should know about their risks, as well as alternatives to payday loans that you may want to consider.
What are payday loans?
Payday loans are a type of short-term, small-dollar loan. They typically must be repaid within a couple weeks — usually through a post-dated check cashed on the borrower’s next payday. Payday loans have high interest rates and are commonly used for loan amounts between $100 and $1,000.
What are the dangers of payday loans?
While payday loans can provide quick cash and may be easier to get than other types of loans, the downsides often outweigh the benefits. Here’s why they are considered risky:
1. High interest rates.
One of the biggest problems with payday loans is their high interest rates. Commonly ranging from 300% to 400% annual percentage rates (APR), these rates can exceed those of other loan options. For example, borrowing $500 from a payday lender might cost $575 or more to repay within two weeks, and the longer it takes to repay, the more the interest will accumulate.
2. Full payment is required quickly.
Payday loan borrowers typically must repay in full by their next paycheck, often within two to four weeks. For many, this short-term repayment schedule can be unrealistic, potentially leading to financial problems.
3. Fees add up fast.
Payday loans can also come with high fees in addition to their interest rates. Late payment fees, rollover fees and other charges can quickly escalate the total cost of the loan.
4. Rollovers can be costly.
If you’re unable to repay your payday loan by the due date, many payday lenders offer rollovers, allowing you to extend the repayment period. However, this typically comes with extra loan fees and added interest. Borrowers can end up in a cycle of borrowing, repaying and re-borrowing.
5. Potential credit score damage.
Because payday loans typically don’t require a credit check, payday lending may seem appealing to borrowers with poor credit, or “bad credit.” However, failing to repay a payday loan can potentially impact your credit score negatively.
First, the loan provider may attempt to collect the debt by cashing your check multiple times. The bank may even charge you overdraft fees or additional fees each time a withdrawal is unsuccessful.
If that doesn’t work, or if you close your checking account, the lender may attempt to collect the debt through calls and emails, and even contact people you listed as references. If the loan remains unpaid, it could be sent to a collections agency or lead to legal trouble, which can hurt your credit score.
While some payday lenders don’t report to credit bureaus, delinquent loans sent to collections can show up on your credit report. This can harm your ability to secure future loans and credit options.
6. Wage garnishment.
Some payday lenders require access to your bank account, or include clauses that allow them to garnish your wages if you can’t repay the loan. This means your paycheck could be partially withheld to repay the loan.
7. The cycle of debt.
The short repayment terms and high costs make it easy to fall into a cycle of repeatedly borrowing payday loans to stay afloat. This cycle can keep a borrower in perpetual debt, draining your savings and leaving no room for financial growth. This may create a long-term debt trap that’s hard to escape.
What are some alternatives to payday loans?
Thankfully, you don’t have to turn to payday loans during a financial emergency. Various online payday loan alternatives can provide you with needed funds — potentially at a lower cost.
Installment loans
Installment loans allow you to borrow a lump sum and repay it in smaller, predictable payments over time. They may come with lower interest rates and more flexible repayment terms compared to payday loans.
Lines of credit
A line of credit functions almost like a credit card, allowing you to draw cash up to a specific limit. It’s a more flexible option than a payday loan, giving you ongoing access to funds that you can borrow as needed. With a line of credit, you only pay interest on what you withdraw.
Additionally, repaying a line of credit often restores available funds, allowing for ongoing access to funds when needed.
Who offers payday loan alternatives?
A variety of lenders and organizations provide payday loan alternatives. Some examples include:
- Credit unions often offer lower-interest emergency loans with longer repayment terms to their members.
- Banks may have personal loan options for borrowers with steady income or mostly good credit histories.
- Online lenders offer alternatives to payday loans, such as installment loans or lines of credit. These options often include longer repayment terms and lower fees.
- Nonprofits and local organizations may provide emergency cash assistance, interest-free loan programs and other financial services.
Where can I get a payday loan alternative?
You can find alternatives to payday loans in many different states and cities. These include:
Are payday loans worth it?
While payday loans may seem like a quick fix in times of financial strain, their downsides can far outweigh the benefits. High costs, rigid repayment terms and the risk of falling into debt make them a risky choice for most borrowers.
Payday loan alternatives, like installment loans or lines of credit from reputable sources, may offer more sustainable solutions to your cash flow challenges. When possible, avoiding payday loans for safer, more manageable options will likely be your best bet.
DISCLAIMER: This content is for informational purposes only and should not be considered financial, investment, tax or legal advice.
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