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The Dirt on Payday Loans (and How to Avoid Them)

Oct 15, 2018 4 min read John Schmoll

Key Takeaways

  • Payday loans are designed to trap you in debt.
  • They carry devastating interest rates of 300% to 500%.
  • Avoid them by building an emergency fund.


When I was 23 years old, I graduated college with a history degree and $50,000 in debt. Desperate to earn extra money to make my minimum credit card payments, I did everything from selling plasma to pawning my high school class ring. When unexpected car troubles befell me, I felt my only option was a payday loan. Thankfully, a friend stepped in and helped me see that I would only go much deeper into debt choosing that option, so I didn't take one out, but I came awfully close.


Looking back, I wish I had known the value of saving up a $500 or $1,000 emergency fund to handle surprise expenses without being tempted or ensnared by a payday loan.

If you think a payday loan might be your only option, here are some reasons to avoid them and consider another, less risky option.

Scary stats on payday loans

If you've taken out a payday loan, you may already have experienced some of these frightening statistics firsthand.

  • Heinously high APRs – Payday loans carry APRs, or annual percentage rates, of 300% to 500%. For example, if you borrow $500 at 400% APR, you will pay $75 every two weeks in interest on that $500 loan.
  • Seriously short-term lengths – Most payday loans are due on the borrower's next payday, which is usually two weeks later.
  • Ferocious fees – According to a recent Pew Charitable Trust study on payday loans, roughly 12 million Americans use payday loans annually, paying an average of $520 in fees to borrow $375.


What makes payday loans so bad

Clearly, there is a need for small, short-term loans. People spend billions of dollars a year on payday loans. Much of that spending is tied up in fees that trap borrowers in cycles of debt that can become nearly impossible to break. Payday loans are generally small, usually for several hundred dollars, but carry incredibly high costs. It's not uncommon for people to pay far more in fees than the amount they borrowed.

For example, the Consumer Federation of America states that payday loans typically charge 400% annual interest or more and carry finance charges from $15 to $30 to borrow just $100. This results in interest rates of 390% to 780% on a two-week loan.

Payday loans are dangerous. In fact, the Consumer Federation of America shows that they're prohibited in 18 states and the District of Columbia. Not only are the fees and interest rates exorbitantly high, but their terms can also be deceptive, making it easy to get in over your head and trapped in repeat loans.

Payday loans are designed to trap borrowers in debt. If you can't pay your loan back in full when it's due, you must renew it, extend it, or take out another loan to cover the first one. Fees are charged for every transaction. Worse, many payday loans are secured with a post-dated check or access to your bank account, making it easy for lenders to take rapidly-accruing fees straight out of your bank account.

The extra money you must pay in fees keeps you from getting ahead financially, and ends up costing you much more than you would've spent if you'd waited to make the purchase or used a less predatory lender for your loan.


Healthier alternatives to payday loans

Payday loans are typically taken out to meet a short-term need, such as unexpected car repairs; a sudden healthcare expense; or money to help a family member or friend in need. There are ways to meet those needs without taking on the fees and expenses of a payday loan.

  • Hold off on the purchase. If possible, try to wait until you receive your next paycheck to pay the expense. If it's a healthcare expense, you may be able to call the billing department and work out an arrangement.
  • Sell something. Look through your home for things that you can live without that you may be able to sell on eBay, Craigslist, or even at a pawn shop to raise the money you need.
  • Use your credit card. Normally, using credit to finance purchases is not a great idea. However, if you need it to meet a need and are committed to paying off the balance as fast as possible, it's better than a payday loan.
  • Consider a personal loan. A local bank, peer-to-peer lending site or even an online loan can all offer better terms than a payday loan to meet a relatively small, immediate need.

Any of these alternatives are preferable to a payday loan, but even better is adopting financial habits that will help you steer clear of payday loans down the road.

Do this now to avoid payday loans later

Uncovering the destructive nature of payday loans reveals the need for a better way to handle unexpected expenses. These three actions can help you find the money to pay for flat tires, medical bills, and other surprise costs in a financially healthy way:

  • Create a budget — In a spreadsheet, with an app, or on a piece of paper, create a monthly budget. Write down your income (all the money you have coming in each month), and write down your expenses (all your bills, both regular and irregular expenses from groceries to gas to utilities to swim lessons). Going forward, make financial and lifestyle choices that result in a positive balance at the end of each month.
  • Boost your cash flow — Find ways to cut expenses (cut coupons, eliminate luxury expenses, downsize, etc.) or look for legitimate ways to make extra income so you have more money to work with each month.
  • Consider refinancing your debt — If credit card or student loan debt payments are chewing up your income and driving you to consider payday loans for unexpected expenses, refinance that debt to a lower monthly payment to free up the money you need to balance your budget.


What you can do next

If you don't have an emergency fund, start one now. While many experts suggest saving three to six months of living expenses in an emergency fund, you don't have to save it all at once. You can start small. Avoid payday loans in the future by using your emergency fund to handle unexpected expenses.


John Schmoll is the founder of Frugal Rules, a finance blog covering investing, budgeting and frugal living. He is a father, husband and veteran of the financial services industry who's passionate about helping people find freedom through frugality.


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