Although there are some signs that the U.S. economy is improving, many people are still struggling to pay their bills each month. Some turn to payday loans to quickly get the cash they need, but this type of borrowing can make your financial situation worse and trap you in a cycle of very high-interest borrowing.
What are Payday Loans?
Payday loans are small, short-term cash loans. There is no credit check and no collateral is required to secure the loan. You usually receive the funds the next day.
To get a payday loan, you write a personal check to the lender for the amount you are borrowing plus any fees. The lender gives you the cash and holds that check, usually until your next payday. On that day, you must pay back the loan plus all fees in full. Some lenders ask for electronic access to your checking account and deposit your cash in that account. They can also automatically debit the amount borrowed plus fees if you do not pay back the loan on time and in full.
What Happens if You Can't Pay Back the Loan on Your Next Pay Day?
If you do not have the money to pay back the full amount you borrowed plus any fees, you can roll the loan over. You then have to pay additional fees and have until next pay day to pay off what you owe plus all the fees you've built up.
The problem with payday loans is that while the fees may seem low at first glance, they are actually very, very high when you consider the annual percentage rate (APR) the lender is charging. Consider this example from the U.S. Federal Trade Commission (FTC): if you borrow $100 for two weeks from a payday lender and pay a $15 fee, the APR is 391%. That rate increases each time you roll the loan over.
While payday loans are supposed to be short-term, on average borrowers become indebted for more than half a year according to The Center for Responsible Lending, a non-profit, non-partisan organization focused on fighting predatory lending practices.
Smart Alternatives to High-rate Payday Loans
There are a number of different approaches you can take if you cannot pay your monthly bills.
- Talk to your creditors. Contact your creditors and ask to set up a payment plan that lowers your monthly payments.
- Look into a personal loan from a credit union or other local financial institution. These lenders often offer short-term loans at much lower rates than payday lenders.
- Consider borrowing from family or friends. Keep in mind, however, that borrowing from family and friends can put stress on your relationships if you don't pay the money back in a timely manner.
- Explore a cash advance from your credit card. While the rates for cash advances are higher than for most secured personal loans, for example, they are still very much lower than the interest rates on payday loans.
If you're having financial problems, it's also helpful to talk with a non-profit credit counseling agency. They can help you set up a budget and build a plan to get out of debt.