The Dangers of Payday Loans | CreditShout

The Dangers of Payday Loans

By Dawn Allcot / July 30, 2010

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Do you need just a few dollars to get you through to next payday? Have an unexpected expense come up, but you have no savings or credit cards to use? For many people in this unfortunate financial circumstance, the answer is a payday loan. But is this a wise financial choice to cover emergency purchases — or even everyday expenses — when your cash runs short?

Sometimes called “cash advances,” these loans were listed as one of the five most dangerous loans by Bankrate.com. How do payday loans work and what exactly is so dangerous about them?

How a Payday Loan Works

When you go to a check cashing place or another business that offers payday loans (including some that operate solely over the Internet), you write the lender a check up to the amount of your next expected pay check, usually post-dated for two weeks later. The lender gives you a “cash advance” on that check, and you can spend the money however you’d like.

You can get a payday loan with no credit history or a bad credit history. Even if you have a credit score of 520 and a recent bankruptcy, you can get a payday loan. All you need is a job. The check is collateral for the money borrowed, your personal guarantee you will pay back the loan at the end of two weeks.

At the end of two weeks, you would use the money from you incoming paycheck to pay off the loan. If you don’t, the lender will cash the check.

The interest rates for a payday loan can equal as much as $20 for every $100 borrowed. That’s an interest rate of 521%. Yes, you read that correctly. Yes, those rates are tantamount to usury. Currently, 17 states have declared payday loans illegal. Many companies get around the law by incorporating their business in a state that has not yet made payday loans illegal.

Danger #1. Exorbitantly high interest rates.

If you don’t pay back the payday loan after the 14 day period, you’ll face additional finance charges of $20 on a $100 loan. You’ll be stuck in an endless cycle of debt with no easy way out.

Danger #2. Danger of bounced checks.

If you don’t pay back the loan, odds are it’s because you’ve already spent the money elsewhere. When your lender cashes the check, it could bounce and you’ll face returned check and overdraft fees from your bank, in addition to owing money to the payday loan company. If the payday loan check clears, other checks you have written may bounce.

Danger #3: Endless debt cycle.

If you are living paycheck-to-paycheck and need to take out a payday loan, chances are your next paycheck is already allocated for next week’s bills — perhaps for gas, groceries and to put a little bit toward your monthly rent.

When you take out a payday loan, it’s like spending your money before you earn it, and you will always be a week or two behind on your bills. Add the exorbitant interest rates into the mix, and you’re just digging yourself deeper and deeper into debt until the only solution may be bankruptcy.

Alternatives to Payday Loans

If you’re in a situation of needing a payday loan, creative thinking may yield some other — better — solutions:

  • If possible, borrow money from family or friends, with an arrangement to pay them back in small increments each week.
  • Work out payment arrangements to pay for the unexpected emergency expenses — doctors, mechanics and contractors may be willing to accept payments.
  • Consider bartering for what you need.
  • Ask your employer if you can have an advance on your paycheck. This isn’t ideal because it will still put you a week or two behind on your living expenses, but at least you’ll forego the 500% + interest rates.
  • Sell belongings on eBay or hold a garage sale. If family or friends have things they’d like to get rid of but don’t have the time or desire to sell them, ask if you can sell their stuff, too, and split the money with them.
  • Do odd jobs for neighbors and friends that pay cash. Yard work, auto detailing, babysitting, and small home repairs can all earn cash — quick.
  • Apply for a secured credit card, like a MasterCard or Visa from Orchard Bank. This isn’t an immediate solution because you’ll still need to come up with a security deposit, but it will insure that you have a credit card to use next time you run into a financial emergency. A secured credit card will also help you build up your credit history and credit score to create a better financial future for yourself.
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