Sometimes, there is no shame in admitting that you may be short of cash and you need access to money to meet important expenses. A lot of people go for payday loans when they need some extra money right away to pay off necessary expenditures. While a payback loan seems like a convenient and viable option, you need to be a little careful not to get carried away. The thing about payday loans is that their fees and interest rates can make them a pretty expensive option. If you are not in the best possible financial circumstances, you might not be able to pay the debt on time and that can drastically increase your financial burden.
While we are not saying that you should not consider seeking payday loans entirely, there are some things you need to know about them. Understanding how payday loans work properly will help you make the right decision about them.
How Payday Loans Work
According to the National Conference of State Legislature, payday lending is allowed in 37 states in the country. A payday loan essentially allowsa loan applicant to take the amount of their upcoming paycheck in advance in the form of cash. The amount you take as a loan is not that much, while the time you have to repay the loan is short as well. So, qualifying for a payday loan is easy.
In order to apply for the loan, you can do it either online or visit a store that offers them. The maximum amount you can borrow depends on the state you live in. But, payday loans of up to $500 are common. Also, you need to be an adult, have a valid ID, show proof of your income, a phone number and a checking account to collect the loan.
If you decide to go to a payday loan store, you need to write a personal check to the business for the amount you will borrow and the fees you need to pay for it. Online and on-the-phone applications require you to give the lender the authority to debit the amount from your account. You can also use your debit card to apply for a payday loan (just in case you were worried about that). You can read more about it to find out how.
The lender will deduct the amount from your account and include the fees for the amount borrowed. The fees can range from $15 to $30 for every $100 you borrow.
The loan terms are usually from two to four weeks. If you pay it all back on time, you are good to go, but if you don’t, you may have the option to extend the loan.
Some states also allow lenders to renew payday loans. They allow borrowers to pay just the fee balance and extend the due date.But, they charge another fee for that.For example, if you borrowed $200 and the fee is $30, you can extend the loan period by paying $30 plus an additional $30 to get more time to pay the $200 back. Essentially, you will be paying the lender $260 instead of the $230 you initially owed with the fees.
Why Payday Loans are Not the Best Idea
Considering how much this can cost you just for the fees is alarming in itself. If you think of all the fees charged on loan as an annual percentage rate, you will be quite shocked. Compare the interest rate and fees to the loan amount and then calculate it over the period of a year to find out the annual percentage rate of a payday loan.
Here’s a simple example to explain:
- Principal Amount (the amount you borrowed): $800
- Interest (the fees charged): $120
- Repayment term (the time you need to pay it back in): 14 days
- Divide the interest by the principal amount: $120 / $800 = 0.15
- Multiply that by 365 (for the number of days in a year: 0.15 x 365 = 54.75
- Divide by the length of payment term: 54.75 / 14 = 3.91
- Convert this into an annual percentage rate by multiplying into 100: 0.391 x 100 = 391
The annual percentage rate for an $800 loan with a $120 fee is around 391 percent. Compare that to the interest of credit card users with a reasonable credit will get an annual percentage rating of around 20 to 25 percent.
There are other penalties that can be applied on the loan as well, which come with additional charges. These include a nonsufficient funds fee if you deposit a check, but don’t have the amount in your account.
When Are Payday Loans Helpful?
With that being said, payday loans are definitely helpful in some situations. That is the reason why they are there in the first place. For instance, if you need a bit of cash for a very short time and you are absolutely sure you can pay it off with your next paycheck, you should definitely go for it.
Payday loans are quite useful if you need to make a crucial payment. An upcoming rent payment when you’re at the end of the month or anything else. Maybe a pressing health concern and need the cash for immediate medical expenses? A payday loan can come in handy in situations like that.
There are rare occasions where you can use a payday loan to stave off a financial emergency, but you should never even think about doing it for an amount you cannot pay off after two weeks. Without having access to proper funds within the allotted time, a payday loan can turn from being a savior to an instant nightmare for you.
All you need to do is make sure that you adjust your budget and take the loan only when you are absolutely sure you can repay it with your upcoming paycheck. Payday loans are not reported to credit bureaus unless the issue is referred to collections, which can affect your credit score adversely. In a nutshell, apply for a payday loan when it’s absolutely necessary and you will find it to be very helpful indeed.