Understanding Why Payday Loans Are A Very Bad Deal

by Hank

Lets face it, most people who have to turn to a payday lender for a loan are scared. Many feel like they have no other option because they need the money right away, have poor credit, or do not know that there are other options available instead of taking the high interest rate loan from a payday lender.

According to the Community Financial Services Association of America (CFSA), more than 22,000 payday advance locations across the United States extend approximately $40 billion in short-term loans to millions of people that experience cash-flow shortfalls between paydays. To give you a simple comparison, Starbucks has 8,624 U.S. locations and McDonald’s about 14,000.

When a customer receives a payday loan, he or she writes a check for the amount of the loan and a finance charge. The lender agrees not to cash the check until the next payday which is typically in two weeks for most Americans. Payday lenders usually provide the check-writer with $50 to $500 in the meantime. Payday lenders have often been vilified in the media for their high fees and interest rates. Most payday loans have a typical fee of $17.50 per $100 borrowed. So, for example, current law allows lenders to charge 15% of the face amount borrowed which must also include the fee for the loan. So, in order to borrow a net amount of $100, the consumer must write a check for $117.62 ($117.625 x .85 = $100). Most lenders simply round off the $17.62 interest fee amount to $17.50.

The real shock to borrowers comes from understanding the interest rate you are charged. While on the surface it seems like you are only paying the equivalent to 15% interest on your loan ($17.50 on every $100 loaned), people tend to forget that the loans only typically last for two weeks and must be repaid on your next payday. The annual interest rate for most payday loans is equivalent to a staggering 456% APR for the two-week loan if it was rolled over and carried out on an annual basis.

Many critics of the financing say that payday loans are not like business or home loans because payday loan agencies do not evaluate a person’s cost of living or ability to afford the payments. Lenders give a borrower two weeks to repay the loan which is often impractical and most customers cannot fulfill. Many borrowers who cannot repay may choose to rollover the loans several times which may lend to a spiral of more debt.

There are other options for someone who is desperate for cash. You might want to consider borrowing money from a pawn shop, borrowing against your car title, borrowing from friends and relatives, getting a personal bank loan or signature loan, or even peer-to-peer lending through a website like Lending Club. While some of these choices might not be most wonderful options, they are head and shoulders above payday lenders.

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