What are payday loans?
A Payday Loan is a short-term loan for a small amount of money with high-interest rates. In essence, borrowers take out payday loans for an immediately urgent expense as they wait for payday, hence the name.
How it works
You need a £100 advance for two weeks, you write a post-dated check payable to the lender for £ 115, which is the amount you want to borrow with the £15 fee you must pay for borrowing. The payday lender gives you the amount of the check minus the fee and agrees to hold the check until your next payday when the loan is due. Come payday, the lender deposits the post-dated check into his own account to redeem the cash or you may choose to roll-over the loan. You will be charged £15 more to extend the loan for 14 more days.
If you choose to electronic payment instead of post-dated check, the company, with your permission will on your next payday debit the amount borrowed electronically or roll-over the loan for an additional fee of £15.
The fee that you will be charged on initial £100 payday loan is £15. If you translate the £15 finance charge into an annual percentage rate, the projected annual interest rate will be 391 percent. Should you choose to extend the loan three times; the £15 fee would increase to £60 to borrow the £100.
The high fees charged on payday loans leads to snowballing of unaffordable debts. Borrowers get caught in a cycle of debt where they continually borrow new loans in order to set off existing loans.
Payday Loan Drawbacks
Here are some of the pitfalls of taking out a payday loan:
- High-Interest Rate
The major drawback to borrowing money from a payday lender loan as opposed to taking out a small loan or overdraft from other conventional lenders such as banks or building society is the high-interest rates. The average interest rate on a typical payday loan is about 400% with some lenders being known to charge as high as 500% annual interest rate. If you take out a loan from other financial institutions, you will pay lower interest rates.
- Additional Fees May Apply
Payday loans have a lot of hidden charges on top of the loan capital and interest. These fees which include "origination fee" or a "processing fee is assessed for every amount borrowed. Most payday lenders impose these charges as a way to get around interest rate caps enforced by state law. The lender is required to disclose these fees in paperwork. Before you agree to a payday loan it is advisable to read the fine print carefully so that you are aware of any fees that will be charged.
Defaults or late repayment can attract additional fees or charges. To avoid those additional charges, you should only borrow a payday loan if you sure that you can repay the entire loan plus interest within the agreed timeline.
- Automatic Payments
Payday lenders claim access to your bank account or require post-dated checks for automatic payment. If the money is not available and your balance rises, they will continue pulling the money out and you will incur overdraft fees.
- Encourage a cycle of debt
In most case, the borrower will be unable to repay the loan by the due date because of the high-interest rates and high repayment instalments. The client ends up securing another loan to set off the first. This leads to a cycle of debt, one that you may eventually be unable to end.
- Damage to Your Credit Rating
If you are unable to repay the loan on time, the payday loan lender may report you to a credit rating agency. This information will lower your credit rating for as long as seven years before it is reviewed. A Negative credit report can lower your credit worthiness. If you want to take out a loan in future, you may be required pay higher interest rates or be turned down for a loan.
- Unscrupulous Lenders
Payday loans require that you provide delicate financial details, such as bank account information, in order to acquire a loan. Unscrupulous lenders may take the advantage to misuse your information. It is important to do proper research and to verify the details of the lender and their licensing to avoid dealing with a dishonest lender.
In most cases, unscrupulous lenders will give debt collectors your confidential financial information. The debt collectors may intimidate you into making additional payment even after paying the payday loan. It is therefore important to keep proper records on any transactions pertaining to the payday loan.
Alternatives to Payday Loans
Here are some options to consider first before you decide to take out a payday loan:
- Consider making and adhering to a realistic budget to avoid unnecessary expenses and allow for savings
- Consider selling your household goods and clothing to avoid borrowing
- Consider the possibility of taking out a loan from family or friends.
- Consider taking an interest-free advance on your salary from your employer
- Consider a modest loan short-term loan from your bank or credit union with more competitive rates.
- Consider taking out an overdraft protection from your bank on your checking account.
In view of the above, it is clear that payday loans are just a short-term solution to your financial woes and may make you incur more debts in an effort to pay off your first loan. Payday loans can lead you into an endless cycle of debts jeopardizing your financial security. It is advisable to find an alternative to payday loans but if you must, borrow the amount you can afford to settle with your next pay check.