Payday Loans: A Guide (and Warning) for First-Timers

Payday loans are very short-term loans that can only go as high as $1000, depending on state legal maximum, and they must be repaid on your next payday, hence the name. To get the loan, you must write a check for the amount borrowed plus a fee. The due date is usually two to four weeks after the loan was made, and the exact due date is agreed upon on the payday loan agreement.

Payday lender stores and payday lenders online will have to verify your income, as well as your checking account. They do this because the money you borrowed, and the repayments will be coursed through this bank account. The lenders will require that your paycheck be automatically deposited to this verified account, and the post-dated checks coincide with your payday. This ensures that the lenders are paid back on the scheduled date.

If you can’t pay your debt on time, lenders usually allow you to roll the debt over, so that the loan gets extended. You will have to pay interest every two weeks while the original balance remains outstanding. Some states regulate fees and interests by outlawing them altogether or imposing caps on the number of times you can renew.

Why are payday loans not a good idea?

The most glaring pitfall with payday loans is the cost. The finance charge can cost between $15 to $30 to borrow $100, with annual interest (APR) going up to 400 percent or more. For loans that last two weeks, finance charges can result in interest rates from 390 to 780 percent APR. For comparison purposes, credit card APRs range from 12 percent to 30 percent.

Payday loans can really be attractive as it requires no credit checks. All you need is a bank account in relatively good standing, a stable source of income, and identification. Payday loan lenders do not necessarily check for the borrower’s ability to repay, but rather the lender’s ability to collect; and this is the very reason payday loans can create a debt trap.

People who take payday loans usually end up trapped in an ongoing borrowing cycle. One payday loan almost certainly entails the need for a second, then a third, and so on. The whole reason for the need for a payday loan is the lack of money for an emergency, and since regular earnings can only cover for regular expenses, chances are borrowers are not better off two weeks later.

What can you do to avoid having to take out payday loans?

The good news is you can take precautions so you won’t find yourself taking out a payday loan for an emergency.

• Build an emergency fund. No matter how small, setting aside an amount every payday can be a huge help in the long run.
• Build good credit so that you can borrow from mainstream lenders.
• If you find yourself always in a tight budget, consider taking a second job, or a side job to increase your income.
• Declutter and sell stuff you don’t need anymore. Having a couple of garage sales every year can help you save a few hundred dollars, and keep your house free of clutter, as well.

What should you do to avoid bad debt?

• Don’t leave a balance on your credit card. Make sure you pay on time to avoid any unnecessary penalties.
• Instead of a payday loan, take out a small personal loan from a reputable bank. Make sure that the loan you take out has a low-interest rate, and is something that you can pay off fairly quickly.

If you can pay cash for a second-hand car, consider that instead of getting a brand new one if it means paying in installments.

This article originally appeared on payment1.com.