Payday Loans: The Dangers
Most payday loans are used by 12 million Americans each year to cover unexpected expenses or manage their income volatility. Use payday loans 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 poor credit and result in the voiding of their bank account (checking account or savings account).
Are payday loans legal in the USA?
Payday loans have been banned in 22 states across the USA due to their high payday loan interest rates and hidden loan fees.
Payday loans work: Why are people getting them?
Many people don’t have other options. A payday loan may be the only way to cover borrower’s monthly income gaps for someone who is low in wages, has unpredictable income, or is facing an unexpected emergency for your emergency fund. 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 one payday loan by charging a rollover fee. The principal of the loan proceeds will not change.
Many payday borrowers find it difficult to repay their loans for months or even years.
Many times, exorbitant fees are much higher than the loan amount. Some borrowers pay thousands in rollover fees. Avoiding online 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 loans 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 it 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 payday.
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: Know 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 an annual interest rate at which you will pay interest on a loan. An APR includes fees for borrowing the loan. The length of your loan term will determine how much you pay. Understanding principal and interest is key to understanding APR.
“Principal” refers to the amount of your new 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 is 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 plan?
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?
Do you have to pay a fee to your lender if the monthly payments are declined because of an overdraft?
Pitfall #6 – Getting trapped in a cycle of debt
Research shows that 8/10 payday loan borrowers have to roll over 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.
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