What's Dangerous about Taking Out a Payday Loan?

What's Dangerous about Taking Out a Payday Loan?

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5 Min Read

Payday lending is often considered a synonym of predatory for a reason. Although payday loans can provide a quick fix in case of emergencies, they also come with several dangers and may cause bigger financial problems. At 1F Cash Advance, we stand for responsible borrowing and want to help our customers make informed choices. Let’s find out how obtaining a payday loan can affect your financial life.

What Are Payday Loans and How Do They Work?

Payday loans are short-term, high-interest debts that allow you to borrow between $100 and $1,000, regardless of your credit score. These loans typically need to be repaid in full within 2 to 4 weeks. The due date is usually tied to a borrower’s next paycheck.

Borrowers can get payday loans completely online without undergoing a hard credit check via major credit bureaus. This makes them accessible to those who can’t borrow money from a bank or credit union. Most payday loan providers prioritize a borrower’s ability to repay over their credit score. Additionally, they offer next-day or same-day funding, making their loans suitable for emergencies.

However, payday lenders often apply very high loan fees, which are the price you need to pay for the risk they carry. This, along with short repayment periods and ease of access, can catch vulnerable individuals into debt traps.

Who Uses Payday Loans the Most?

Payday loan borrowers are typically people who need money quickly and can’t access more affordable forms of financial assistance. In other words, they target individuals who are vulnerable to predatory lending. Here are the demographics that are most likely to borrow money from payday loan stores or websites:

  • Renters;
  • 25-44 years old;
  • Individuals who earn less than $40,000 per annum;
  • Parents with minor children, especially divorced ones;
  • Underbanked individuals;
  • Borrowers with bad credit;
  • Recent migrants, African Americans, and Hispanic people.

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What Are the Dangers of Payday Loans?

Although not all payday loan lenders use unethical and deceptive practices (learn more on payday loan scams), payday loans still bear multiple risks for borrowers. Let’s take a closer look at their main dangers.

High APRs

A payday loan is one of the most expensive loan options on the market that comes with significant overpayment. Payday loan interest rates are typically expressed in a flat fee. You can be charged between $10 and $30 for each $100 borrowed. Although it may not seem that much at first glance, it turns into a sky-high price in terms of an annual percentage rate. An average payday loan APR is about 400%. For comparison, personal loans usually come with APRs between 5.99% and 35.99%.

Short Repayment Terms

Unlike a personal loan that you can repay in a series of affordable monthly installments over several months or years, a payday loan needs to be repaid in full within up to 31 days. Payday borrowers who already experience financial problems may find it difficult to cover the debt within such a short timeframe.

Potential Debt Cycles

If you can’t repay your loan on time, a payday lender may offer you a rollover. This option will make your loan even more expensive due to the fees applied to the entire amount you owe, including interest. Statistics show that 4 out of 5 payday loans are re-borrowed, with 1 out of 4 being renewed nine times or more. Thus, borrowers end up paying more in fees than they initially got in credit.

As renewals and rollovers are prohibited in some states, many people are forced to take out a new payday loan just to repay the existing one. All these create a cycle of debt that can be quite difficult to break.

No Credit Check

Payday lenders typically don’t conduct hard credit checks. Although many borrowers consider it an advantage, it’s actually not. By skipping the verification and offering simple access to cash, loan providers attract borrowers who can’t handle the debt and are doomed to a cycle of debt.

Access to Your Bank Account

Most payday loans require access to your active checking account. This means that a lender will be able to withdraw the money from it when the maturity date comes. If your bank account balance won’t be enough to repay the loan, this will result in extra fees charged by both the lender and your bank. If the loan provider makes several attempts while you don’t have enough funds to repay, you will have to pay overdraft fees for each of them.

Possible Credit Score Damages

Even though payday lenders don’t make credit report checks, there’s still the risk of a credit score drop if you default on your loan. On top of that, on-time payments won’t help you build credit, so you only risk ruining your rating without a single opportunity to improve it.

Payday Loan Alternatives

Here are a few alternatives to payday loans

  • Installment loans. These are unsecured loans offered by online lenders. While they have longer repayment periods and lower interest rates compared to payday loans, they are also available to people with poor credit. Just keep in mind that extended repayment terms may also result in more overpayment over the loan life;
  • Payday alternative loans (PALs). PALs are offered by certain credit unions to protect their members from predatory lenders. These loans allow you to borrow up to $2,000 and repay the funds within up to 6 months. Additionally, an interest rate won’t exceed 28%. Learn more: Payday Alternative Loans for Bad Credit.
  • Secured loans. A secured loan is a way to get a higher loan amount against some of your valuable assets (secured vs. unsecured loans). This option comes with lower interest rates and longer repayment terms of up to 84 months. However, you can lose your property if you stop paying;
  • Peer-to-peer platforms. P2P loans are available via digital platforms. They are offered by individual investors who lend money to other people. With their help, you may get flexible loan terms at competitive rates;
  • Paycheck advances. Paycheck advances are cash advances you get from your employer. Simply put, you receive a portion of your future paycheck upfront without paying any fees;
  • Family loans. Your loved ones may be willing to lend you a helping hand if they have a sufficient amount on hand.

Bottom Line – Reasons to Avoid Payday Loans

Ease of obtaining and accessibility make payday loans very attractive for bad credit borrowers who need money fast. At the same time, their high cost and quite questionable loan terms can easily trap them in a debt cycle. Consider all the pitfalls of payday loans carefully before going into debt and pay attention to more affordable alternatives.

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Edward Evans

Written by Edward Evans

Written by Edward Evans

Edward Evans is a money management expert and a freelance author of personal finance columns. He aims to provide accessible financial advice to improve financial literacy for average Americans and inspire them to take control of their personal finances and build wealth.

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