Fast cash or payday loans are some of the most accessible financial instruments in the market today. It allows customers to borrow a couple of hundred dollars which are made payable on the next paycheck. Unlike other types of loans, payday loans are the easiest ones to qualify for, making them a seemingly good solution for financial emergencies.
But what many borrowers fail to realize is that payday loans are also one, if not the most expensive type of loans there is. With APR amounting to 400%, you surely have a lot to pay for borrowing a small amount.
But why are payday loans so expensive and why do lenders charge such high interests? Here are the reasons.
Why Payday Loans are Expensive
1. To Mitigate the Risk
Say, someone approached you to borrow some money. But you happen to know that this person is too “generous” with his money and spends it rather carelessly. He has poor credit and little savings. You want to lend him some, but you’re also apprehensive that he might not pay it back. So you talk to the person, telling him he can borrow your money but you’ll charge a higher interest which might force him to pay the loan back on time.
The idea is that if the interest hurts so much to the pocket, you’d rather strive to pay it back promptly than to keep the interest from growing. Payday loan lenders typically roll over the interest from one month to the next if you missed your first deadline. As you keep missing your due date, the interest would also keep ballooning. We must remember that lending payday loans is a business and lenders make profit from the interest.
Most payday loan borrowers are high-risk. They often have bad or little credit. Payday loan lenders care less about your creditworthiness and put more emphasis on financial capacity.
2. You Pay for Convenience
What if one day you’ve found out that your car has one busted tire and you direly need to replace it? Your paycheck is still a couple of days away, you’ve maxed out your credit card and you don’t have cash in hand. Payday loans can help solve financial situations like these. You only need to apply online or visit the lender’s physical store. You also need to provide some basic documents like proof residence, identity and income. Once approved, the loan should be in your account in a few hours. Easy-peasy, right?
The thing is, you also pay for speed and convenience, and that reflects into your loan’s high APR. You don’t need to go through credit check and provide collateral. You also don’t need to provide a mountain of documents and then wait for a couple of days for approval. Payday loans are so handy and accessible, yet getting them comes with a high price to pay.
3. Short-Term Small Loans Are Generally More Expensive Than Long-Term Huge Loans
All loans’ interest are expressed in APR or annual percentage rate. In payday loans, APR is expressed as the flat rate that is charged to the original amount. For instance, when you borrow $100 in payday loans, it will come with $15 fixed rate. By your next paycheck, you will need to pay $115.
Therefore, if you borrow $100, you would have to pay another $15 as APR. However, since payday loans are short-term loans and are payable in approximately two weeks, the APR is applicable within this loan term. If you keep rolling the loan over, you also add another layer of $15 to the original loan amount. This process keeps going until you’re able to pay the loan in full.
The extra $15 you pay on your original loan may seem small, but as it turns out, many borrowers need to keep rolling their loans because they’re unable to keep up with their due dates. This is how cash-strapped borrowers fall into an even deeper debt pit.
Now, it is important to compare the cost of loans in APR as it will give you a more solid idea on which loans offer the best deals. Short-term loans like payday loans are more expensive than long-term loans, such as personal loans.
HOW TO GET AWAY FROM PAYDAY LOANS
Fortunately, payday loan lenders are under the country’s usury laws. These laws protect consumers from illegally exorbitant APRs. Additionally, lenders are obliged to impose a maximum ceiling amount for payday loans, which ideally helps borrowers restrain themselves from getting into more debt.
Still, you would want to consider payday loans as your very last resort. In fact, if you manage your finances properly and identify more manageable financing options, you may never even have to take payday loans.
First of all, always consider emergency as part of life, like needing to get a bad tooth out or replacing old and worn roof after a storm. Your first line of defense should be some sort of liquid savings that you can use for any type of emergency so you don’t have to withdraw money from your real savings. This is called the emergency fund.
The emergency fund acts as your buffer from unexpected expenses. Instead of taking cash advance of your credit or borrowing money from family, the emergency fund gives you instant relief without the interest or having to borrow money from other people. Aim to save at least three months worth of expenses and save it in an accessible account. You want to be able to use your emergency fund even if it’s two o’clock in the morning.
If the emergency fund is not enough and you badly need some extra money, consider getting personal loans instead. Personal loans have lower interest rates. You can borrow a larger amount of personal loans than from payday loans. Also, personal loans are long-term loans, allowing you to pay it month after month with fixed installment amounts.
Payday loans may seem like a good solution, but they should never be the first ones. Given their expensive APRs, missing just one payment could potentially lead to a vicious cycle of debt. Life will throw you curveballs, but you don’t always have to go into debt if you handle your finances properly. And if you direly need financing, consider looking at more affordable and less stressful options like personal loans.
Disclaimer: Content found on loanreviewhq.com has been created to be used for informational purposes only and help readers achieve a basic understanding of their finances and financial options. The content is not intended to replace or usurp financial advice from professional accountants, CPAs, etc. If you you’re seeking financial advice, always present any questions you may have regarding your finances to a professional. Never disregard professional advice because of something you read on the internet.