On paper, payday loans can seem like a financial lifeline. They don’t require a lot of red tape, and funds are available almost immediately. However, a closer look at the lengthy stipulations, obscenely high interest rates, penalties and potential financial ruin associated with defaulting on a payday loan will reveal a money-grubbing beast dressed up like easy money.
Payday loans are extremely tempting to borrowers who need a short-term loan because they aren’t difficult to secure and are processed in a timely manner. Plus, credit checks are not typically necessary for approval, making the process simpler and smoother if you have blemishes on your financial record.
A lender will use your next paycheck to “fund” a payday loan. But the money you have to pay back will well exceed the amount of the loan, thanks to the lender’s fees and interest rates.
“A payday loan is essentially an advance against your next paycheck. You give the payday lender your pay stub as proof of income and tell them how much you want to borrow. They give you a loan for that amount, which you're expected to repay when you receive your paycheck, along with the payday lender's fee,” according to The Balance writer Jeremy Vohwinkle.
Since a payday loan can incur high interest rates that “can range up to 500 percent in annual percentage yield,” according to Investopedia editor Julia Kagan, the risk of not paying it back should be a sobering concern for borrowers. Not being able to pay it back can send borrowers into a black hole of loan extensions, ultimately making it near impossible to settle the once-small debt.
“They find themselves unable to repay the loan on payday, so they extend the loan for another pay period. They continue spending borrowed money and in the meantime, the fees continue piling up. It's a vicious cycle, and it's one that can continue indefinitely since there is no limit on how many times a person can get this type of loan,” reports Vohwinkle.
If you are unable to pay back your payday loan, your financial woes are just beginning and will impact every aspect of your financial life. According to NerdWallet writers Liz Weston and Amrita Jayakumar, you can expect incessant calls from collection agencies, overdraft fees applied to your bank accounts, bank account withdrawals, credit score destruction and possibly legal action.
Thankfully, a payday loan isn’t your only option to secure a short-term loan. Vohwinkle suggests asking for an advance on your salary from your employer, seeking assistance with a pawnshop loan, applying for a cash advance through your credit card or asking for help from your friends or loved ones. Each of these methods have potential drawbacks, but they are less severe when compared to the financial pitfalls of a payday loan.
Payday loans sacrifice a portion of your future paycheck and their steep interest rates can propel you into more financial potholes. When it comes to payday loans, the adage “buyer beware” has never been more fitting.