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Payday Loans: The Dangers

Payday loans are used by 12 million Americans each year to cover unexpected expenses or manage their income volatility. Payday loans can be used to address a real problem but payday lenders are often abused by consumers.

The real dangers of payday loans

It’s not unusual to hear horror stories about people being charged more than 1000% APR, or falling into debt traps.

If a person gets into a spiral of debt with unending rollovers and hidden charges, it can cause damage to their credit and result in the voiding of their bank accounts.

Are payday loans legal in the USA?

Payday loans have been banned in 22 states across the USA due to their high interest rates and hidden fees.

Payday loans: Why are people getting them?

Many people don’t have other options. A payday loan may be the only way to cover income gaps for someone who is low in wages, has unpredictable income, or is facing an unexpected emergency. Although it won’t solve all financial problems, it can provide temporary relief. Here are a few important points on payday loans.

  •       Payday loans that exceed 80% are not repaid immediately or rolled over to another loan are often taken out.
  •       Lenders that don’t have policies to prevent rollovers or offer flexible repayment options can lead you in a financial trap

What happens to someone trapped in a debt trap cycle?

Lenders will usually agree to defer repayment if a borrower is unable to repay their payday loan by charging a rollover fee. The principal of the loan will not change.

Many borrowers find it difficult to repay their loans for months, or even years.

Many times, fees are much higher than the loan amount. Some borrowers pay thousands in rollover fees. Avoiding lenders that practice rollovers is the only way to avoid falling into debt traps.

Payday loans: How can you avoid falling for these traps

It is possible to avoid payday loan dangers by learning basic financial skills.

It is vital to be fully informed about payday loans, as many borrowers don’t have other options. Here are important points to help you out:

Pitfall #1: Don’t consider cheaper alternatives

Consider all your options before you apply for a payday loan. These options may help you avoid borrowing money via a payday loan.

  •       Reduce impulsive purchases to reduce discretionary spending
  •       Earn Extra Income by Side-Working. To make extra income, you can do freelance work, side projects, or any other part-time work.
  •       Sell Personal Possessions That You Don’t Use Anymore.  Give your old stuff to someone who can use or to a Pawn Shop.

There are also other borrowing options available that might be less expensive than a payday loan.

Credit Card Advance

Consider getting a credit card loan and repaying it when you receive your next paycheck.

Personal Loans

To cover your expenses, you can apply for a personal loan at a bank or credit union.

Advance from the Employer

Asking for an advance from your employer to have the money taken from your next paycheck could also be an option.

Borrowing money from friends and family

You can borrow money from your relatives and then repay them. This option is often interest-free.

Pitfall #2:  avoid unlicensed lenders

Unlicensed lenders may also be referred to as loan sharks and should be avoided.

Unlicensed lenders are not licensed and often exploit consumers by charging high interest rates, trapping them in debt, or using illegal collection methods.

On the other hand, a licensed lender is authorized to do business within your state and is bound under the laws of that state. Contact your state regulator or attorney-general to confirm if a lender has been licensed.

Pitfall #3: Payday loan middlemen

A payday loan “middleman”, is a website or institution that does not lend money directly, is known as a payday loan intermediary. To get a payday loan, one must go through several companies acting as payday loan intermediaries.

Direct lending is often safer and more affordable than traditional payday loan intermediaries. This means that fewer companies will have access to your personal data and you will be less likely to pay a brokerage fee.

Pitfall #4: known the cost of your payday loans

The Annual Percentage Rate (APR) is a measure of the amount you will have to pay to take out a loan. An APR is the annual rate at which you will pay interest on a loan. An APR includes fees for borrowing the loan. The length of your loan will determine how much you pay. Understanding principal and interest is key to understanding APR. 

“Principal” refers to the amount of your loan. “Interest” refers to the amount you pay the lender in addition to what you borrowed. The APR (annual rate) is a measure of how costly the interest rate relative to how much you borrowed. When calculating total cost, remember to consider the length of the loan. 

Pitfall #5 – Be aware of the hidden fees

It is a smart idea to inquire about all fees that may be applicable to your loan. Here are some of the most common hidden fees you should be aware of:

Loan Application Fee

Do you have to pay a fee in order to apply for a loan?

 Undisclosed Late or Missed Payment Fee

Do you have to pay a fee if you make a late payment or miss a payment?

Returned check fee

If your check is returned due to any reason, would you be required to pay a fee?

Customer Service Fee

Do you have to pay money to speak to a customer service representative?

Overdraft Fee

Do you have to pay a fee to your lender if the payment is declined because of an overdraft?

Pitfall #6 – Getting trapped in a cycle of debt

Research shows that 8/10 payday loan borrowers have to rollover their loan at some point. If the borrower is unable to repay their loan on time, a rollover will result in a fee. 

Many borrowers find themselves in a “debt trap” cycle, where they are required to pay multiple rollover fees over the life of their loan. Avoid rollovers if you don’t want to get trapped in a debt cycle. These tips can help you avoid falling into debt traps.

Bottom line

Payday loans should not be taken out if you aren’t sure you can repay the loan on time.

  •       Look for a payday lender that doesn’t allow rollovers
  •       Look for a payday lender that offers extended repayment options
  •       Get familiar with the laws governing payday lenders in your state
  •       Learn about the different ways to get out of debt if you are already in it

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