LIFESTYLE & COMMUNITY

Payday Loans: Everything You Need To Know To Not Fall Into A Debt Trap

Date October 23, 2018 16:16

Probably all of us have faced a situation where we desperately need money at least once. Nowadays, there are lots of ways to solve this problem. For instance, you could lend some cash from a friend of yours, ask your boss for an advance, or try to get an additional source of income, like the second job. Another option is getting credit from your local bank, of course. However, some people are 'lucky'  to have a possibility of payday loans, also known as 'cash advances'.

You’ve seen those storefronts and online ads for quick loans for sure. But do you know how these loans work, and why it can be extremely bad for your finances in mid- to long-term perspective? We are here to clear things out for you and prevent you from falling into the debt trap of payday loans.

Payday Loans: Everything You Need To Know To Not Fall Into A Debt Trapmikeledray / Shutterstock.com

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What is a payday loan and how does it work?

Short-term, unsecured loans with exceptionally high interest rates, also called payday loans, are considered a remedy for financial emergencies. However, according to experts, these types of loans are beneficial only for people who need some extra money to be able to make it to their next paycheck. Payday loans are available in most states, and it is known that one in ten Americans have used them at least once in their lifetime.

It is pretty easy to get a payday loan. All you need to have is just your valid ID, proof of your steady income, and an open bank account. With these documents, you can go to a store that provides the payday loan service and borrow the needed amount of money. In general, this amount is capped between $300 and $1000.

The typical loan term is two weeks and costs around 400% (annual percentage rate (ARP)) from the borrower’s perspective. Payday loans are based on a set dollar rate, for example, $20 per $100, which is equal to around 500% of ARP. If you cannot repay the loan fully and in time, you may be faced with additional fees.

Payday Loans: Everything You Need To Know To Not Fall Into A Debt Trapdesigner491 / Shutterstock.com

A simple example of a payday advance: let’s assume you’ve borrowed $500 with an ARP of around 400%. With the help of a few simple calculations, you’ll owe around $580 in just two weeks. And depending on the lender, you might owe already more than $1000 if you don’t repay the debt in two weeks! And although it’s probably not a big deal to use a payday loan once or twice, many people roll over it multiple times and got stuck in a debt loop. According to experts, it is the only reason why this type of loans work and benefit payday lenders. Basically, a lender gets a substantial profit only when the borrower gets on the hook and renews the loan at least six to eight times.

Payday loans: Advantages and disadvantages

Now let’s talk about whether you should consider taking a payday loan or not. As already mentioned, this type of loan is designed for people to get extra money before their next paycheck. However, most people use payday loans for regular expenses such as rent or utilities, and rarely to deal with unexpected financial emergencies. Statistically speaking, payday loans pose a huge threat to any citizen, especially those who have low income. However, there is a bright side as well.

The pros:

  1. Fast extra money that is easy to get to solve your short-term financial issues.
  2. No credit check is needed.
  3. You receive the cash instantly.
  4. You can take out a payday loan online. Just avoid the websites that have any additional charges.

The cons:

  1. Probably the biggest downside of payday loans is the high interest rate.
  2. High risk of falling into the debt trap.
  3. Possible additional fees and penalties may be applied to you.
  4. Your credit rating will be affected. As the consequence, some companies might reject you due to your credit history.

As we can see from the analysis above, the benefits of payday loans are short-term, while every negative aspect is relevant in a mid- to long-term perspective. So before taking out a payday loan, it is wise to consider every other possibility.

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Upsetting statistics of payday loans: draining the resources out of American lower class

Payday loans are allowed in most states (36 in total). Other states either forbid the practice or have hard restrictions making it almost non-profitable for lenders. Every state has its own regulations regarding the maximum loan and the limitation of the APR. According to the Consumer Financial Protection Bureau, the payday loan industry size in the US is around $9 billion! Just imagine the number of people who are stuck in the debt loop or just used the loan once. Well, 1 out of 10 Americans has taken out a payday loan at least once in their lifetime. Moreover, 1 out of 50 Americans borrows money this way annually!

If you want to know which states allow payday loans, we have prepared this simple infographic below.

Payday Loans: Everything You Need To Know To Not Fall Into A Debt Trap

 

The highest annual percentage rates are in Ohio, Nevada, Idaho, Texas and Utah – more than 650%! The lowest APRs are in Oregon, New Mexico, Maine and Colorado – around 200% and less.

For those who are fascinated by numbers and statistics, here are the most interesting facts regarding the payday loan business:

  1. More than 80% of all payday loans are rolled over (renewed) within two weeks. However, some states have so-called “cooling-off” periods, preventing frequent loans.
  2. Almost half of the borrowers continue the sequence up to ten loans!
  3. In more than 80% of all payday loan cases, the last loan is at least the same size or higher than the very first one of the sequence. This is associated with high interest rates, forcing people to borrow more money.
  4. Only 60% of the borrowers took out only one loan of those who didn’t renew the loan during the year.
  5. An average borrower is in debt for more than five years and spends around $520 in fees.

Who uses payday loans: demographics

According to the Pew Charitable Trusts report, older adults (over 70 years of age) are the least likely to take out a payday loan. It is mostly people ages 25 to 50 who get payday loans. It is interesting to know that according to the data, African American are twice more likely to borrow money this way. Moreover, the following groups are at risk of taking out payday loans:

  1. People whose income is less than $25,000 a year.
  2. People who haven’t completed a four-year college education.
  3. People who rent are twice more likely to use payday loans than homeowners.
  4. Parents are more likely to take out cash advances than people who don’t have children.
  5. Separated or divorced people are more expected to use payday loans than those of the other marital status.
  6. Disabled or unemployed people are also likely to use this service.

Payday Loans: Everything You Need To Know To Not Fall Into A Debt TrapRawpixel.com / Shutterstock.com

There are more payday lenders nowadays than McDonald’s restaurants! Unfortunately, this means that the business works for them just perfectly. Be careful, most people who have taken out cash advances find themselves even poorer. We hope that you will not fall victim to this scammy business!

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