You’ve likely seen Payday Loan lenders advertise themselves on television as places to easily receive fast cash when it is needed most. Lenders will tell you that a payday loan can be a useful way of paying off car repair bills, medical expenses, or other unexpected emergencies. But is taking out these types of short-term loans really a good idea?
How a Payday Loan Works
Say you want to borrow $500 from a payday loan lender. Upon asking for this money, the lender will likely ask to see a pay stub, a bank statement, and when your next payday will be.
So let’s say you get paid $1,000 every 2 weeks, and your pay stub indicates that. And let’s say that your next payday is 2 weeks from the day you borrow the loan.
Now, when you borrow the $500 from the lender they will ask you to agree to pay some sort of an interest rate on the loan, which is likely to be incredibly high (ranging from 15 to 30 percent). In this example, we’ll say that the lender is asking you to pay a 25% interest rate.
Before you leave with your borrowed money, the lender will ask you to write a check dated for when your next paycheck is expected to arrive. The amount that you will write on the check will be the amount you owe the lender at the end of the interest cycle. So in this case where you’re borrowing $500 at a 25% interest rate, the amount you will come to owe buy your next payday is $625.
When you’re payday comes around you’ll have the option to either payback the loan with cash at the storefront, or they will cash the check you wrote out on the day you took out the loan. They do this because they want first dibs on your incoming money, ensuring that the loan will be paid.
Is Taking Out a Payday Loan a Good Idea?
If we look at this from a mathematical standpoint, we can see that this is obviously a very bad deal.
The interest rate you are being charged with this loan is 25% per 2 weeks.
$500 x 25% (or .25) = $125
But let's look at what this rate would be as an Annual Percentage Rate (APR).
Annual Percentage Rate:
There are roughly 52 weeks in a year, so if you’re paid every 2 weeks that means you are paid 26 times a year.
25% x 26 = 650% APR
Take note that the national average APR for credit cards is 15.07%. So this is an insanely high number.
The only practical answer here is, NO. A Payday loan is never a good idea. Unfortunately, these lenders don’t make it seem that way on their commercials, and there are plenty of people with very low credit scores that do not qualify for a credit card or have any other form of borrowing power, but yet they still have expenses that must be paid.
Exhaust All Other Options
Better alternatives to payday loans would be: budgeting out your finances, paying for only what you can afford, asking for a pay advance from your employer, borrowing from a friend or family member, or even pawning off some of your valuables.
If you absolutely need cash and have no other alternative, be extremely careful with the amount of money you take out from these lenders. The debt can pile up fast and put you in an endless borrowing cycle—a situation that you do not want to be in.