Here’s what you need to know about payday loans and how they can impact your financial health.
What are payday loans?
Payday loans are short-term unsecured personal loans that must be repaid by your next payday. To ensure that the payment will be made, the lender requires a postdated check that includes the borrowed amount, interest and fees. Payday loans tend to carry exponentially higher interest rates than personal loans – sometimes as high as 400 percent – and can come with a plethora of hidden fees. Because of this, they are often criticized for being predatory, particularly for borrowers with bad credit, who may not have another option for fast cash.
“The best way to identify a payday loan is any time you borrow money and you pay back the entire amount at once, normally your payday,” says Jeff Zhou, co-founder and CEO at Fig Tech. Additionally, most payday lenders don’t run a credit check; if the lender isn’t interested in your credit history, this could be a warning sign that you’re dealing with a payday lender.
How they work
Payday loans can typically be obtained through either a physical brick-and-mortar location or an online application process. To determine your rate and terms, the payday lender may request a hard credit check to view your credit score, although this is less common with a payday loan. The lender will also generally require proof of income and your pay date.
When you’re approved for a payday loan, you give the lender a postdated check that it can deposit on your next payday. If you take out an online loan, you authorize the company to take the funds from your bank account once you’re paid by your employer.
Your credit score isn’t as large of a factor with payday loans, because the lender has the authority to take its payment from your bank account when you get your next paycheck. That’s how payday lenders minimize their risk. They also can base the principal amount of your loan on a percentage of your predicted income.
Payday loans can sometimes seem too good to be true, since they’re more accessible than a personal loan or a credit card cash advance. But if you’re not careful, payday loans can be dangerous; the high rates and fees cause many borrowers to default or fall into a cycle of debt, which can cause their credit score to plummet.
Why someone would get a payday loan
Payday loans help you get the cash you need quickly, which makes them an attractive option for borrowers with poor credit or little to no financial history. Here are a few reasons why someone would get a payday loan:
- Holiday shopping: A payday loan could seem like a convenient way to immediately get the cash you need for last-minute holiday shopping.
- Emergency expenses: An emergency expense like a car breaking down or unexpected medical treatment can be jarring to your finances. For those with poor credit, a payday loan can seem like the best option to pay for a hospital stay or car repairs.
- Cash with bad credit: If you don’t meet the credit requirements for a personal loan, payday lenders tend to require less from borrowers in terms of financial health and credit.
How to repay a payday loan
After you provide the postdated check and get approved for a payday loan, the full payment – interest and fees included – will be due on your next payday.
If your check bounces or you can’t pay the full balance on the required payday, you may have to roll the loan over to the next payday, accruing more interest in the process.
Risks of payday loans
Due to the high interest rates and hidden fees, payday loans have the potential to derail your financial health and your credit score. “Payday loans charge a high interest rate, but the biggest risk of payday loans is the fine print,” says Zhou.
The fine print can include fees like change fees, mandatory subscription charges or early repayment fees, and these can all quickly add up. “The fine print can create catch-22’s that prevent you from paying off the loan,” says Zhou. “The biggest danger of payday loans is when they turn from a short-term stop gap into a long-term drain on your finances.”
If you don’t have an established plan to pay off your payday loan in full on the requested date, you’ll have to roll over your loan, meaning you’ll be responsible for the principal balance and additional fees and accrued interest. This is a vicious cycle that could land you in high-interest debt down the road.
How payday loans affect your credit
If your payday lender doesn’t require a hard credit check and you’re able to pay back the full amount by the required date, a payday loan typically won’t negatively affect your credit. If your lender does require a hard credit check, you may notice that your credit score drops a few points.
However, if your check bounces or you can’t pay the full balance on the required payday, the amount could be sent to a collection agency, which has negative consequences on your credit and financial history.
Similarly, some lenders may bring you to court in order to collect your unpaid debt. If you end up losing your case, that information could be reflected on your credit report, lowering your score for up to seven years.
Alternatives to payday loans
You might not be able to get a traditional bank loan to meet your quick-cash needs, but some of these methods to stretch your finances to the next payday might work better than a payday loan.
1. Use a credit card
If you have a credit card that’s not maxed out, you could use it to charge your expenses. Not only will your interest rate likely be lower than that of a payday loan, but you’ll have 30 days to pay back the credit card balance before it incurs interest. If you can pay back the money by your next payday, a credit card could be a cheaper option.
2. Get an installment loan
An installment loan allows you to borrow a set amount of money over a fixed time period. Some common examples of installment loans include car loans, mortgages and student loans. You repay the loan over a certain number of payments, called installments. Most installment loans will have a fixed monthly amount that you’re required to pay, and the amount won’t change over the course of your repayment period.
Installment loans are beneficial because they come with a predictable monthly payment. Knowing how much you need to pay each month can help you budget for your monthly installments and avoid missed payments because of unexpected fees.
Keep in mind that installment loans don’t allow you to increase the amount of money you need to borrow. If you need more funds unexpectedly, you’ll have to take out a new loan.
3. Apply for a personal loan online
It’s possible to get a personal loan with bad credit. Some online lenders, such as LendingClub and Earnest, have loans for as low as $1,000 to $2,000. Avant requires a minimum credit score of 580 FICO with an estimated APR that ranges from 9.95 percent to 35.99 percent – significantly lower than the estimated 400 percent that you’d be facing on a payday loan.
With many lenders, you can check your personal loan rates online without impacting your credit score. Once you’re approved, it’s possible to have the money sent to you within one business day.
4. Consider a credit union if you have time
Credit unions offer payday alternative loans (PALs) that allow you to borrow between $200 and $1,000 for a term of one to six months. The APR is capped at 28 percent.
But you have to be a member of a credit union for at least a month to be eligible to apply for PALs, so they won’t be the best solution if you need money immediately.
5. Turn to family and friends
Friends and family might not always be able to lend money, but sometimes they can help in ways that can lessen your expenses. For example, they can let you do your laundry at their place, which can save your costs at the laundromat, or they can make dinner for you and give you leftovers that will last until payday.
Don’t be afraid to open up to people who are close to you about your financial struggles. It takes a village – and one day you’ll be there for them, too.
6. Generate income quickly
There are a few things you can do to generate extra income quickly. One way to make extra cash is by selling some of your stuff that you can live without. Have clothes you can get rid of? Try selling them online or at local secondhand stores.
You also can explore renting out a room on Airbnb, trading in your unused gift cards for cash or cashing in any unused rewards points on your credit cards.
7. Ask your employer for an advance
Check with your employer if you can get an advance on your paycheck to tide you over. Your HR or payroll department may be able to find a way to help you out.
8. Seek leniency to reduce or delay payments
If you owe money on certain bills, it’s a good idea to call each creditor to request an extension on your balance due date until you have the money to pay it back.
Many companies will agree to this leniency or find ways to allow you to make partial payments on your bills. It’s worth checking areas where you can lower or hold off payments to get you through till payday.
9. Use emergency relief services to reduce your expenses
You might be able to save up for any upcoming payment and eliminate other expenses in your budget by using emergency aid services in your community. Here are some ways:
- Local food banks: Reduce or eliminate your grocery bill by accessing the resources of a food bank in your area while you wait for your next paycheck.
- Low Income Home Energy Assistance Program (LIHEAP): This is a program run by the federal government to help families meet their energy needs.
- Local community service agency: Many communities have nonprofit organizations that help residents in times of need. For example, Community Services Agency in Mountain Park, California, offers help with rent, utilities and back-to-school expenses. Some local churches or other religious institutions offer similar services.
10. Consider pawn loans
You could borrow money from a pawnshop by using one of your valuable items as security against your loan. The pawnbroker will hold the item and lend you an amount that typically is a portion of the resale value of the item, often for a high fee.
If you make payments on this loan, you’ll be able to redeem your item. If you stop making payments, the pawnbroker eventually will sell your item to recover its loss.
But a pawn loan is an expensive way to borrow money, with some loans charging APRs upward of 200 percent, and the term length for many pawn loans is just 30 days.
Pawnbrokers don’t report your payment history to consumer credit agencies, so if you don’t pay off your loan it won’t impact your credit. But you’ll lose the pawned item.
How to choose the best option for you
If you need money immediately, use this criteria to determine which quick-cash alternative method is right for you:
- Which loan will have the lowest interest? You might have an easier time repaying a loan if it has lower interest. In general, it might be possible to negotiate terms with lower interest rates on loans from family members and friends.
- Can you build your credit? It’s better to build your credit before you get a loan, but if that’s not possible, getting a loan from an institution that will help you simultaneously build your credit – such as a payday alternative loan from a credit union – could be a good way to get the money you need while also boosting your credit history.
- Can you repay the loan while meeting its terms? No matter the lender you use, you might be setting yourself up for trouble if you don’t have a plan to repay the loan while meeting its terms. A critical step in understanding which loan is right for you is finding one you can afford.
Payday loans can certainly be beneficial under the right circumstances. If you have a sound financial history but just need a bit of extra cash to cover an expense, a payday loan could be a great option. However, remember that payday loans come with risks, and if you’re not confident in your ability to repay your debt, a payday loan could ruin your credit score or even land you in court.
Before getting a payday loan, speak with banks and credit unions about your loan options and find the best rate available. The dangers of payday loans often outweigh the benefits, so ensure that you know exactly what you’re signing up for before applying.