We’ve all had times when we’re a little short on cash. But if it has happened to you a few times lately, maybe you’ve tapped out all of your usual sources.
You can only ask family and friends for an extra $100 until payday so many times before they give you that look.
At this point, you may consider trying a payday loan. I get it, desperate times call for desperate measures. But this option usually makes things worse, not better thanks to killer fees. Our list of alternatives to payday loans can help you find a better option.
Understanding a Payday Loan and How it Works
A payday loan is a specific type of short term loan. The loan will be due within a matter of days after receiving the cash, so it’s intended for those who have a financial emergency.
It’s not made through a traditional bank, so the borrower doesn’t need a good credit score or significant collateral. In fact, the payday lender will not run a credit check on the borrower. There’s no hard inquiry on the credit report, either, which helps the borrower avoid a negative mark on the credit score.
Sounds pretty good right?
Not As Good As It Sounds
While that all sounds great, the payday loan is too good to be true.
You’ll get slammed with fees.
This type of loan will have an incredibly high fee structure. If you’re in financial difficulty, paying it back on time with the fee can be a serious challenge, leaving you in a significantly worse situation than when you received the loan. And the longer you go without paying the loan, the worse the fees get.
Credit cards have a reputation for having really high fees and interest. But they don’t come anywhere close to the ruthlessness of payday loans.
Many people have trouble paying back the loan on time, which forces them to borrow again, continuing the cycle of debt and racking up extra fees with no end in sight.
And if you become delinquent, the lender may turn your account over to a collection agency. This will trash your credit score for years to come and you’ll get hounded by collection agents around the clock.
Methods of Getting a Payday Loan
To receive a payday loan, you can either apply online or visit a payday loan store. Finding one isn’t hard. It seems like the stores are in every strip mall these days.
The application process will take 10-20 minutes in person, and you can have your cash immediately if you quality. If you apply online, you usually will have the money electronically transferred to your account within 8-24 hours.
What Do I Need to Qualify?
When you apply in person or online, you usually will need to show proof of a bank account. You also likely will need to show proof that you have a job, typically with a recent pay stub.
At the time you receive the loan, you often will write the lender a check for the due date of the loan. Or you will give the lender the ability to make an electronic withdrawal from your account on the loan’s due date.
The due date typically syncs to your next payday (usually up to 14 days away). If you have not paid back the loan (with fees) before the due date, the lender will cash the check or run the electronic withdrawal. If you don’t have the funds to cover the payment, you’ll be delinquent.
If you know you will not have the money to repay the loan and fees, you will have to return to the borrower before the due date and work out payment terms. For most people, this unfortunately involves obtaining another payday loan, and the cycle continues with even more fees.
Understanding The Math: What’s The Cost of a Payday Loan?
When you actually take the time to figure out the true cost of a payday loan, it’s mind-boggling that these things are still legal in most states. Some states don’t even put a cap on the fees.
Calculating a Payday Loan’s True Cost
The majority of payday loans are made for between $300 and $1,000. Each state is a little different as to how much you can borrow.
For our calculation example, let’s use $500 for the original payday loan amount. And let’s say the lender charges a 12% fee, which is $60 in this case. So your payback amount is $560.
At first blush, $60 doesn’t sound like a terribly high fee. Remember, though, you only have that $500 for roughly 14 days. On a typical bank loan, such as for a car or a home, you borrow the money for several years.
Understanding APR on a Payday Loan
If you calculate the $60 fee using APR (annual percentage rate), which is the typical interest rate calculation on bank loans, the true cost becomes outrageous. Your APR for this payday loan is roughly 313% (because you’re only borrowing the money for 14 days).
For comparison, a credit card charges you 15% to 25% in annual interest. An auto loan can have an APR of 4% to 7%. A mortgage loan’s APR can be as little as 3% or 4%.
If you end up having to reborrow the payday loan money over and over, say every two weeks all year, you’d have $1,560 in fees on that original $500 at the end of the year. That’s a crazy fee for being behind by one pay cycle.
Why Is the Fee Rate So High?
Granted, the borrower is taking on a high risk with a payday loan. You’re paying for the privilege of not needing a credit score or collateral for the loan.
I’d also make the case that payday loans blatantly take advantage of folks. If you’re desperate or don’t know how payday loans work, the payday loan company can set any terms they like. That means ridiculous fees and tons of profits for them while folks get sucked into a pit of debt.
Why Payday Loans Are Inherently Bad
A recent report showed 60% of Americans aged 22 to 37 don’t have enough in a savings account to cover a $1,000 emergency expense. This is the core group of people on whom payday loan companies prey.
Another study shows 58% of people who take out payday loans already have trouble meeting monthly expenses. This is the last group of people who can afford to use payday loans. They just end up digging a deeper financial hole with the high fees.
Despite all this, payday loans are immensely popular.
12 million Americans annually use a payday loan service and about 75% of people using payday loans have taken out more than 10 of these loans previously. All these fees add up to a $9 billion industry. About 80% of payday loans are made to repay an earlier payday loan.
That looks like rampant exploitation to me.
The fact that some states ban this type of loan should tell you all you need to know about the legitimacy of them. For states that do allow payday loans, they often limit the amount of money someone can borrow.
Good Payday Loan Alternatives
Even though payday loans rarely solve financial problems, and even though most people know this, they’re still popular. Sometimes, you desperately need some cash.
Multiple options exist that could accomplish the same end goal as payday loans with a much less punitive fee structure.
- Borrow from someone: You could borrow a small amount from family or friends. Some people dislike doing this, because it can lead to hard feelings if the borrower delays paying the money back. But as long as you’re diligent about paying the money back, most people are happy to help you out temporarily with a no interest loan.
- Credit card advance: If you have a credit card with room below the credit limit, you often can take out cash. There are fees here too and interest rates are high, but they’re pretty reasonable if the alternative is a payday loan.
- Negotiate: See if the business or person to whom you owe money will give you a bit of extra time to make payments. You usually only have one chance at this, so use a realistic timetable on how you plan to pay the money off over time. I did this for the last semester of college tuition. I couldn’t make the full payment on time, talked to them, and got a 12 month payment plan going.
- Payroll advance: Some employers allow employees to borrow small amounts against a future paycheck (usually with a reasonable interest rate). This is not a common option these days but it never hurts to ask. You may be able to spread out the payback amount over multiple paychecks.
- Peer-to-peer loan: This is a relatively new option, where websites connect someone willing to lend personal funds with a borrower. However you often need a good credit score to qualify.
- Personal installment loan: Local banks, federal credit unions, and online banks may be willing to lend you money you can pay back over time. Usually, you don’t need collateral. But you may have to wait a few days to receive the money, and you often need a good credit score.
- Personal line of credit: A personal line of credit is an open borrowing line with a bank you can use whenever needed, paying it back over time. But it usually requires some collateral.
- Personal loan for bad credit borrowers: A few local and online banks will lend people money who have poor credit scores, either with or without collateral. While these will be high interest loans, they won’t be anywhere near as high as payday loans.
- Refinancing: If you have a car or a home that has a greater value than what you owe on it, you may be able to put it up as collateral to obtain a lower interest loan from a bank. A reverse mortgage is a similar type of option.
- Sell something: Selling some of your possessions isn’t a great option, but it gives you the cash you need quickly without paying fees or interest rates.
Is There Ever a Good Reason to Get a Payday Loan?
Really, the only reason to take out a payday loan is if you have an emergency payment that just can’t wait. With the payday lender, you’ll have your cash in hand within 15-20 minutes, which is faster than the majority of alternatives on our list.
Before taking out this type of loan, be absolutely certain you can pay it back within the 14-day timeframe and that you won’t have to continue borrowing. Also read the fine print. The fees are designed to hit you at every turn. And expect the final amount to be much higher than what they tell you. If you can’t pay back the original amount properly, you’ll want to try some of the alternatives we listed in the previous section instead of the payday loan.
Avoid Payday Loans
Even though the majority of people know the dangers of payday loans, they still receive plenty of use.
I would recommend exploring all other alternatives before going to the payday loan store.
If you fully understand the cost of this type of loan, and you still believe it is your best option, then you’ll have your cash in as little as 14 minutes. Just make sure you have the original amount plus the hefty fee ready to pay back in 14 days, or you’ll be digging a deeper hole for yourself.