If you drive through any city, it’s likely you’ll see storefronts for payday lenders. Payday loans are widely available and popular with people who need money for an emergency and don’t see another way to get it quickly. However, these loans can be risky and it’s important to understand how they work before you get one.
Addition Financial members often ask us:
“Are instant payday loans safe to use?”
We think that’s an essential question and it’s one we’re happy to answer. In this post, we’ll explain the risks and benefits of payday loans and give you some alternatives that we know are safe.
How is a Payday Loan Different from a Personal Loan?
A payday loan is a short-term loan that provides instant money to be loaned against the borrower’s next paycheck. In most cases, the borrower must agree to allow the lender to withdraw money from their bank account to repay the loan when it comes due.
The lending requirements for payday loans are minimal. Usually, all you need is a valid ID, proof of income and a bank account. You can usually get the funds the same day or the next day without a credit check.
Bad payday loans are typified by astronomical interest fees that sometimes put them in the category of predatory lending. According to CNBC, the average rate is 15% to 20%.
By contrast, a personal loan is generally something that involves a traditional lender such as a credit union or bank. There’s a loan application process that includes a credit check and proof of employment and income. The interest rates are determined based on federal rates plus your credit score.
Personal loans usually take longer to receive than payday loans and they have lower fees and interest rates. Unlike payday loans, a personal loan is an installment loan, meaning that you’ll make regular monthly payments until the loan balance has been paid in full.
What Are the Costs and Fees for a Payday Loan?
The thing that makes payday cash advance loans predatory is the exorbitant interest rates associated with them. Because the fees are so high, many payday borrowers end up rolling over one loan into a new loan. Ultimately, they pay far more than they borrowed in the first place.
The biggest cost associated with a payday loan is the interest. At an average rate of 15% to 20%, the interest is high by any standard. It’s important to note that due to the short-term nature of payday loans, the annual interest rate is astronomical.
Someone who took out a payday loan for $500 at a 15% interest rate, which is at the low end of the spectrum, would pay back $575 after 14 days, which is the average length of a payday loan. That translates to a 391% annual interest rate. The annual rate is the rate you should be comparing to credit union or bank loans.
In addition to the interest, you may also be required to pay late fees if you miss a payment or need more time to pay.
Does Paying Back Payday Loans Build Credit?
Payday loans differ from personal loans in some significant ways. One of the most important things to know is how payday loans will – or will not – impact your credit score.
Let’s start with credit building. It is not common for payday lenders to report instant payday loans to the three major credit bureaus. Even if you make all your payments on time, it is unlikely to have any impact on your credit score.
The same is true if you default on your loan. Many lenders who do emergency short-term loans don’t have the mechanisms in place to report delinquencies or defaults.
There is no credit check required to receive a payday loan, so your credit score won’t take a hit from a credit inquiry either. However, if you fail to pay back your loans and go to court, the court proceedings will appear on your credit report and stay there for up to seven years.
What Happens if I Default on a Payday Loan?
Some people make the mistake of thinking that because payday loans are typically for small amounts, the consequences will be minimal if they don’t pay back what they borrowed plus any fees. That’s not the case, so let’s talk about what could happen if you default on a payday loan.
The first consequence is likely to be a series of debt collection calls, and payday loan collection calls are relentless. They will call you at work and at home. If you used relatives or friends as references, they may call them if you aren’t responsive to their messages.
Many payday lenders require authorization to withdraw funds from your bank account. If you don’t have sufficient funds, they may try smaller transactions to get what they need. Each failed transaction will cost you money, and you may incur more charges once your account is overdrawn.
When a payday lender can’t collect, they may send you threatening letters from lawyers or even sue you. If you can’t afford to pay your debt, you may need to mention bankruptcy to get them to back off and set you up with an installment plan.
What State Regulations Are in Place for Payday Loans?
The unfortunate truth about payday loans is that they are poorly regulated and in many states, they are not regulated at all. The payday loan industry employs a large number of lobbyists and their efforts have been fruitful. Under normal circumstances, their predatory practices and high interest rates would be considered usury, but they operate in legal loopholes created by lobbyists and politicians.
There have been some efforts to outlaw payday lending, and 12 states plus the District of Columbia have done so. However, most of the remaining states have little regulation in place and some, including Florida, have none.
Most of the regulations in place cap interest rates. However, the interest rates are still high when compared with the rates you’d get from a credit union or bank. For example, Colorado, Montana, South Dakota and New Hampshire cap annual interest rates at 36%. Even people with low credit scores can get a personal loan at a lower interest rate than that.
The lack of legal protection is a big part of why payday loans are not safe. If you get caught in a cycle of borrowing with a payday lender, it can be extremely difficult to extricate yourself from it.
What Are Some Safe Alternatives to Payday Loans?
Now that we’ve established that payday loans are generally not safe, let’s talk about some ways to get money that you can use as a payday loan alternative. These options are safer and offer you some protection while still allowing you to get the money you need.
- Apply for a personal loan from a credit union or bank. Many financial institutions will work with you even if your credit score is low, and you’ll get better interest rates and have more legal protection than you would with a payday loan.
- Borrow from a lending circle. Private lending often has less stringent requirements and lower interest rates than traditional lending.
- Borrow from a friend or family member. While there can be some potential drama associated with family lending, if you put a written loan agreement in place and borrow from someone you trust, it can be a good alternative.
- Get a cash advance on your credit card. While the finance charges for cash advances are high and this might not be the best option, the rates are still lower than they are for payday loans and can be an option if you need cash immediately.
- Get a side gig. Depending on how much money you need and how quickly you need it, you may be able to work a couple of shifts a week to earn what you need.
- Sell your personal belongings. While we don’t recommend gambling with a pawn shop loan, you can sell personal belongings on eBay, Craig’s List or Facebook Marketplace to earn extra money. Just be sure to take precautions when meeting buyers in person.
- Monetize your hobbies. There are a lot of people who enjoy making things, and selling them on Etsy or a similar site can be a great way to put some extra cash in your pocket.
These ideas are all preferable to paying the outrageous rates associated with payday loans. If you are an Addition Financial member or want to join, we’re happy to help you review your options and figure out the best and safest way to get the money you need.
The bottom line is that payday loans can be predatory and dangerous. We strongly recommend against getting one because it’s easy to get caught in a cycle of borrowing that can hurt you financially for years to come. There are easier and more affordable ways to get money to pay a debt or handle an emergency.
Are you looking for a way to get the money you need? Click here to read about Addition Financial’s personal loan options and start the application process!
