Many of us have been in a short-term financial pinch. It could be that an unexpected car repair, appliance replacement or emergency room visit stretched us thin and left us worried about how to make ends meet until our next paycheck. In those situations, many people will use a credit card, borrow money from a family member or friend, ask their boss for a paycheck advance or dip into an emergency fund to cover unforeseen costs.
For people without those financial safety nets available, though, they may be tempted to take riskier measures to keep themselves afloat, namely a so-called “payday loan.” These loans are essentially advances on the borrower’s next paycheck that require no credit check. They are easy to get and are often available 24 hours a day to those who want them. This type of loan definitely shouldn’t be a first-resort, though, because payday loans come at a huge price.
The price of “easy money”
The risk that payday lenders take in lending money to high-risk borrowers (usually those without the credit necessary to get a loan from a traditional lender like a bank or credit union) is counterbalanced by massive fees and extremely high interest rates. On a typical loan of $500 that is slated to be paid back within a month, for example, a borrower would pay a total of about $575. That works out to an average interest rate of well over 300 percent, which is more than 10 times the interest rate of a cash advance on a credit cards and about 20 to 30 times what most traditional lenders would charge for a personal loan.
The real problem with payday loans comes not in their borderline-usurious interest rates, but in the cycle of debt they create. Most people getting these loans are lower-income and already living paycheck-to-paycheck; they don’t really have room in their budget for the added cost of paying back the loan quickly, so they will extend the terms of repayment, tacking on additional fees and interest. A one-time loan of only a few hundred dollars that should have lasted a month can morph into years of repayments and thousands of dollars in interest. Some borrowers find themselves trapped in a cycle of ever-increasing debt from which there is no escape.
New York has already taken steps to limit the impact of these and other predatory loans, and federal regulators are proposing similar rules that would cap interest rates and cut down on the likelihood that a one-time payday loan will result in financial ruin for borrowers. Only time will tell if these federal rules will be passed, or if they would actually be effective at cutting down on the number of these ill-advised loans people take out, however.
If you find yourself struggling to manage your debt, consider speaking with a bankruptcy attorney in your area to determine if a bankruptcy filing might be the best course of action for you.