Trouble with Payday Loans

  • 6 min read

Who hasn’t found themselves strapped for cash at some point? It can be rough when you’re struggling to find a cheap place to eat for lunch, but it’s far worse when the bills are coming due and there’s no hope for paying them in time. These situations are where payday loan outlets – both online and in physical retail locations – love stepping in. They’ll offer a simple and fast solution to your financial woes by allowing you to take an “advance” on your next paycheck. The thinking is that the money is coming to you anyway, so why not get it in your hands now, when you really need it?

Why Payday Loans Are a Dangerous Idea

Unfortunately, it’s not that simple, and payday loan agencies have earned a bad reputation for good reason. Here are some things to consider: (Hopefully, they’ll steer you away from this potentially harmful lending practice.)

  • Insanely high interest rates

When you apply for a payday loan, you’ll have to agree to pay back a lump sum along with the amount advanced to you. As an example, you may need to pay back $550 to borrow $500.

While that $50 fee might seem worthwhile for fast access to that coming paycheck, it works out to an APR of over 300% on a two-week loan. And that’s a generous estimation; some payday lenders apply APRs of over 700% on their cash advances. If that were a credit card or a home mortgage APR, it certainly wouldn’t fly.

  • A downward debt spiral

Payday lenders want to keep lending you money, and they know how the system works. If you were so strapped for cash that you needed to take the loan in the first place, there’s a good chance you won’t be able to pay it off in two weeks. This means they can charge you for an extension – or they may “generously” offer to issue you another, larger loan after you pay off the first.

This is common practice, and it’s how these lenders make their profits. In fact, most cash advance customers end up paying nearly double what they borrowed by the time all is said and done.

  • It’s barely even legal

You’ve probably heard of state usury laws, and they’re put into place to keep institutions from charging unreasonable interest on loans. Despite the fact that a 500%+ APR is certainly unreasonable, payday lenders are often able to use loopholes to their advantage. Usury caps are typically set between 20-40%, so you can clearly see where the line is being blurred.

If payday loans are so awful, then why are all of these lenders still in business? The simple truth is that many people get into situations where they have no other choice. If you find yourself in such a situation, you may want to consider a few safer alternatives before taking that cash advance…

Alternatives to Payday Loans:

  • Cash advance from your credit card. It’s expensive, but probably far cheaper than a payday loan.
  • Borrowing from friends or family could save you a bundle on interest rates and fees.
  • Ask for an extension on the bills you’re anxious to pay.
  • Consult with a credit counsellor. They may be able to help you find a safer alternative to your financial troubles. These professionals are equipped to help with many other debt/finance issues as well.

In case you haven’t heard, let me remind you that Google has put a ban on ads related to payday loans. That’s right…the world’s biggest advertising platform has determined that payday loans are so incredibly awful that they refuse to help perpetuate their existence.

Of course, you probably didn’t need Google to tell you that payday loans are downright evil. These lenders prey on people who are in financial crisis, disguise themselves as “a helping hand,” and then trap borrowers with loans that carry three-figure interest rates. How do you feel about paying over $500 to borrow $300 for several weeks? Sounds like a terrible deal to me.

It’s practically highway robbery and if payday lenders were subject to usury laws, they’d be out of business in minutes. Unfortunately, this isn’t the case, and millions of Americans are falling into their traps every year.

So how do you avoid the dreaded payday loan?

Research shows that the majority of people who’ve taken out a payday loan could have avoided it by lowering their cost of living…sometimes only slightly. (If you’re paying 300% interest for a loan to cover your Netflix bill, your priorities are askew.) In most cases, taking the hit to your standard of living will be much less costly in the long run.

Oh, and do not take out a payday loan to cover a credit card bill. That’s a decision that borders on insanity. Why transfer debt from a roughly 20% APR to an account with an interest rate that’s six, seven, or eight times higher?

Knowing why it’s bad is well and good…but that’s not enough.

Humans are notorious for knowing that things are dangerous and doing them anyway. Just ask anyone in the tobacco industry, a race car driver, NFL players, or…well, anyone with a pulse. We all do it in some form or another.

The trick to is limit the chance that we’ll be forced to make a bad decision. Having safety nets and alternatives in place can do wonders for our decision-making skills! So, what can save each and every one of us from the payday loan trap?

An emergency fund.

Without a doubt, the boring old rainy-day fund is the natural enemy of the payday loan. If you have enough cash on hand to cover an unexpected bill or expense, then you won’t need to run into the “helpful arms” of a lender. Save up a few hundred dollars and you’re off to a good start.

Better yet, take Dave Ramsey’s advice and strive to save up a $1000 emergency fund. Do whatever it takes. Make sacrifices to your standard of living or take on a second job. That emergency fund can – and probably will – change your whole financial attitude and future.

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Christopher - BSc, MBA

With over two decades of combined Big 5 Banking and Agency experience, Christopher launched Underbanked® to cut through the noise and complexity of financial information. Christopher has an MBA degree from McMaster University and BSc. from Western University in Canada.