Why Payday Loans Are Risky and How to Avoid Them

Payday loans are short-term loans that come with high interest rates and hidden fees. Learn why they're risky and how to avoid them.

Why Payday Loans Are Risky and How to Avoid Them

A payday loan is a short-term loan that can help you meet your immediate cash needs until you receive your next paycheck. These small, high-cost loans typically charge triple-digit annual percentage rates (APR), and payments are usually due within two weeks or close to your next payday. Payday loans charge borrowers high interest levels and do not require any collateral, making them a type of unsecured personal loan. These loans can be considered predatory loans, since they have extremely high interest rates, do not consider the borrower's ability to repay, and have hidden provisions that charge borrowers additional fees.

The difficulty arises when the loan is due because by then it is time to pay the next month's bill cycle. In some cases, borrowers sign electronic access to their bank accounts to receive and repay payday loans. You may think that a payday loan is the only solution to handling an emergency bill, or even to pay off another debt, but the truth is that a payday loan will end up costing you more than the problem you are trying to solve. That's why payday loans are risky, it's easy to get caught in a debt cycle, and it's expensive to get them out. Lenders are prohibited from charging more than 36 percent annual interest, including fees; taking a check, debit authorization, or car title to secure loans; and using mandatory arbitration clauses in covered loan contracts.

Because these loans cost a lot and can be difficult to repay, it's almost always best to avoid them. To repay a loan, borrowers can redeem the check by paying the loan in cash, allow the check to be deposited in the bank, or simply pay the finance charge to extend the loan for another repayment period. Financial experts warn against payday loans, especially if there is a possibility that the borrower will not be able to repay the loan immediately and recommend alternative loan sources. Loans can usually be renewed for additional financial charges, and many borrowers up to 80% of them end up as regular customers. Payday lenders used to set up a shop just beyond the perimeter of military bases, gutting soldiers and their families.

Payday lenders rely on regular customers, often low-income minorities, who charge exorbitant compound interest on cash advances. Instead of torpedoing your credit score, immediately notify the lender if you know your loan check will be returned and request a payment plan. Since lenders typically require a post-dated check before issuing the loan, the check will be deposited on the next payday. Because of this, you should only apply for a payday loan if you are absolutely sure you can return it. Pew's analysis of the initial proposal recommends a stronger standard of ability to pay in the CFPB rule and clearer guidelines to avoid excessive loan durations, unaffordable payments and abuse by lenders in accessing checking accounts. Payday lenders use different methods to calculate interest rates, often demanding almost 400% on an annualized basis. Payday loans can be incredibly dangerous for those who don't understand how they work or don't have enough money saved up for emergencies.

They can quickly spiral out of control if you don't have enough money saved up for repayment when they come due. It's important to understand how these loans work before taking one out so that you can make sure you're able to pay it back without getting into further financial trouble. If you're considering taking out a payday loan, make sure you understand all of the terms and conditions before signing any paperwork. Look into other options such as borrowing from family or friends or using credit cards with lower interest rates. If none of these options are available to you, make sure you understand all of the fees associated with taking out a payday loan so that you can budget accordingly. Payday loans can be helpful in certain situations but should always be used as a last resort.

Make sure you understand all of the risks associated with taking out one of these loans before signing any paperwork.

Cara Longendyke
Cara Longendyke

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