You may have driven past a payday loan store and wondered how the process works. Possibly you have struggled with finances and needed some quick cash to help ends meet before your next check arrives. Here's a quick breakdown of what a payday loan is, and why you should avoid them if you can.
How payday loans work
Payday loans are basically short term loans that are often used to bridge the gap between one paycheck and the next. Anyone can walk into a payday loan stand. To obtain the loan, you simply fill out some information and write the lender a check for the amount you want to borrow, plus the anticipated interest on the loan. The payday lender will only cash your check when the loan comes due (usually within 7 to 30 days).
So what's the catch?
Here's the downside to the loans: the interest rates charged are exorbitant! They can range from 10 to 20%. That might not sound too bad (your credit card rate may be similar), but remember that those rates are for very short-term loans. If you were to keep carrying the loan forward, digging yourself into a deeper hole, you may end up owing interest that ranges anywhere from 500 to 2000% of your principal balance per year.
For example, if you need to borrow $400, you would write the payday lender a check for $400 plus the interest, say $80 assuming a 20% interest rate. If you can't pay the loan back within it's two-week due date though, you can take out another loan to cover the $80 finance charge from the first loan. And now, you owe the lender $576 in two weeks (the original $400, plus $80 in interest, plus $96 which is 20% of $480). The hole just gets deeper and deeper until no paycheck you receive is going to be able to cover everything you owe.
These loans very rarely do you any favors. The idea of instant cash may be tempting, but using a credit card is a smarter move than taking out a payday loan. Credit cards have lower APRs, and usually at least give you a grace period. The loans, on the other hand, start charging you interest on your loan from the moment you take it out.
Payday lenders charge such exorbitant rates because they are taking a huge risk by lending to you. They don't check your credit beforehand to see how creditworthy you are, so almost anyone can qualify for a loan. Also, the loans are unsecured, so there is no collateral the lender can collect from you if you skip out on the loan.
The average payday loan
The typical payday loan is usually for a small amount, somewhere between $50 and $1000 (usually around $300). This may seem like a harmless amount to borrow, and easy to pay back, but don't be fooled: the interest rates can be astronomical and can pile your debt much higher than you anticipated.
Beware payday loan identity theft
Identity thieves have been known to use someone else's identifying information to take out a payday loan. This can happen if a criminal gets a hold of one of your checks or sensitive identifying information. Because payday lenders do not run a credit check and because payday loans do not appear on your credit report, only checking your credit will not alert you if a payday loan has been taken out in your name. Consider protecting yourself by enrolling in an identity monitoring service that checks payday lending records for your identifying information.
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