Payday loans are small, short-term cash advances that use a borrower’s paycheck as collateral. Usually, payday loans are made for $500 or less. These loans offer borrowers access to quick cash and are usually due by the next payday. Payday lenders usually provide the funds for a loan via cash, check, or prepaid debit card. Although easy to obtain, borrowers pay dearly for the convenience that payday loans offer.
Payday lenders make their money in the form of finance charges. According to the Consumer Financial Protection Bureau, the cost of a payday loan can range anywhere from $10 to $30 for every $100 borrowed. Not too bad, you say? Let’s take a closer look at the interest charges. We’ll use a hypothetical borrower named Steve as an example. Steve needs quick cash to pay for some urgent expenses and uses the local payday loan shop to take out 5 different loans for $500 each in a given year. Steve agrees to pay the lender $17.50 for every $100 borrowed. After the dust has settled, Steve’s APR on the $2500 borrowed is a shocking 456%!!! Though it’s hard to believe, the math is correct. This is a prime example of why payday loans are almost never a good option. Payday loans should only be used in times of extreme financial crisis. Even in times of crisis, credit cards, which have an average rate of 15%, are a much better alternative to payday loans.
Payday loans are like financial crack cocaine. Lured by the promise of quick cash, borrowers return to payday loan centers time and time again. Without proper education on personal finance, these individuals will continue to perpetuate the cycle of debt until they are completely broke. The best way to avoid the debt cycle can be summed up with one sentence- Live within your means! It sounds easy, but if it were easy, then everyone would do it. The math is easy, but the behavior is difficult. Spend less than you make, save the rest, and you will never find yourself in Steve’s position.