For years payday loans have been attractive to people who are in desperate need of funds. Most people initially believe accessing payday loans will help them out of a short term financial crisis, but in reality, payday loans are not short term and can cause significant financial distress.
Payday lenders are in the business of making substantial profits. So it is not unlikely for them to charge borrowers up to a 500% annual percentage rate (APR) and include hidden fees. In the past, their behavior have been deemed so terrible at times that some consider them predatory in nature.
That said, here are five reasons why you should avoid payday loans if you want to make sound financial decisions.
Payday Loans Encourage A Cycle Of Borrowing
Payday loans do not require credit checks and can be obtained quickly. These qualities make them easily accessible to people who have outstanding debts. Some people borrow the money to pay expenses but are not able to pay the loan in full. As a result, they borrow yet another payday loan. For the economically disadvantaged, the result can be devastating. They can become trapped in a borrowing cycle without an easy way to get out.
Hidden Fees And High-Interest Rates Are Constants
Payday lenders charge the highest interest rates in the market. Like we mentioned before, the APR can be as high as 500%! What’s more upsetting is that they get away with it because they lend to high-risk borrowers, who often consider it a small cost of borrowing.
Payday Loans Are Often Misused
According to a study conducted by The Pew Charitable Trusts, only 16% of people use a payday loan to cover an emergency expense¹. A vast majority take out loans for regular, anticipated expenses like credit card costs, utility bills, or to buy groceries.
Default Can Turn Chaotic
The day of reckoning, when you’re unable to repay your debt, can be unpleasant. Some companies have horrendous debt collection techniques, but the Fair Debt Collection Practices Act (FDCPA) in the United States should shield you from threats of criminal prosecution, harassment and other egregious breaches of your rights.
Extra Fees or Penalties
If you default on your payday loan, you may be charged additional fees, on top of what you what you owe them. In some cases, this has resulted in the doubling or tripling of the original amount you borrowed.
If you find yourself in financial distress, there are a few alternatives that can shield you from payday loans.
The first alternative is your savings account. Most people can’t pay cash for a $1000 emergency². A rainy day or emergency fund will help you avoid a payday loan and interest for an unexpected emergency. Save in small increments and as often as possible.
If that is not possible, consider borrowing money from friends and relatives. Like a savings account, you probably won’t have to pay interest. Just remember to pay your loved ones back!
If neither alternative is available to you, then consider your 401k or retirement account. We don’t encourage borrowing from your 401K or retirement account. The point of these accounts is to compound and accrue profits for the future. Taking money out will not only defeat that purpose, but it may incur tax liabilities. So, only borrow if you are in a desperate situation.
Financial stability is vital for happiness in life. Now is the time to be a good steward of your money. Your bank account, investments, and peace of mind will thank you.
Video credit: PBS NewsHour | Youtube