A payday loan seems like a lifesaver because it provides an easy way to get cash. If you were suddenly met with a high expense without any means of payment, a payday loan might appear as a reasonable alternative to foot such expenses.
In reality, however, payday loans come with many hidden costs that borrowers might not be aware of. Many at times, payday loan comes with a high-interest rate that could cause debt traps for borrowers. This is because payday loans usually have a short payment term. Failure to meet that term leads to the accumulation of fees. Typically, payday loans are recommended for low-income earners and are around $500 or less.
There are various names for payday loans, such as deferred deposited loans, post-dated check loans, or cash advance loans. However, they all follow the same principle.
You will need to write a post-dated check, which will include the full amount and any extra fees to the lender. In other instances, you might authorize the lender to debit your bank account automatically. After these agreements are settled, the lender hands out the cash.
Typically, you have to pay the loan by your next payday, which is usually due in a maximum of four weeks. Failure to meet this agreement gives the lender the authority to debit your account electronically, or the lender can cash the cheque that you handed him.
Many states allow this form of lending. They, however, usually set a limit on the amount payable as loan and the incurable fees. The fees can range from $10 to $30 for every $100, depending on the state.
On the surface, payday loan seems like an easy way out of cash problem. Many people might even see it as a lifesaver. When you, however, understand the actual cost, it might not be worth it. Although, a payday loan might make sense if you are confident of repaying the loan within the stipulated time. Many people, however, do fail to meet this agreement.
Some of the real costs of payday loans are:
Payday loans go hand in hand with high interest rates. In other words, you will have to pay back a huge amount of money should you fail to pay the money back on time. When you consider a payday loan critically, the interest in a single month does cost more when compared to what a credit card would cost you in a year.
In the same manner, some payday loan companies might not charge interest at all. They do have a fixed fee on the amount you borrowed. This means that whether you pay back on time or not, you will pay more compared to a credit card.
If it is only the high payment fee that borrowers incur, it would have been better. However, your credit score rating also takes a blow, in addition to throwing you into a cycle of debt. The problem is that your credit score will suffer even if you pay the loan on time.
Bear in mind that lenders predict your spending habits by considering your borrowing history. Using a payday loan might make lenders consider you as a risky person to lend to. This, thus, affects your ability to get a mortgage.
There are times when lenders never have enough to service their loans. This leads them to a cycle where the debt keeps accumulating and extending to the following month's payday. The danger with this is the additional fee because the money to be paid keeps increasing as the cycle prolongs. Eventually, this might lead to an excessive amount that you won't be able to pay off within a few weeks or months.
The Consumer Financial Protection Bureau reports that around 60% of payday loan borrowers find themselves in this trap. The good news, however, is that you can escape this trap, and this boils down to understanding and coming to terms with your resources. You can use the following strategy to break out of the payday loan trap:
