Avoiding Payday Loan Pitfalls

When you face a sudden financial emergency, you may feel you have very few ways to get out of the situation quickly or easily. Your car may have broken down, preventing you from getting to your job, or maybe your kitchen sink sprung a leak that must be fixed immediately. If you can’t get a short-term loan from friends, family, or an employer, you might consider turning to a payday loan. This type of loan can help you deal with your immediate emergency, but you need to very carefully consider the potential pitfalls before you collect the cash.

How Payday Loans Work

A payday loan is simply a cash advance that is not tied to any kind of collateral. Typically this type of loan is repaid within two to four weeks. Payday loans are used by all kinds of people who need cash quickly, such as within a day or even in hours. Lenders who offer payday loans often advertise that they work with customers who have poor or no credit and few options.

Unfortunately, the default rate, or percentage of payday loans that aren’t repaid, is high. Consequently, payday loan companies set a high interest rate to recoup money from customers who do pay back their loans.

Payday Loan Legality

About one third of the states in the U.S. have some type of legislation in place that makes payday loans illegal. The primary reason for these laws is the extremely high interest rates many payday loan companies charge. The interest accrued on the two- or four-week loans, when figured on an annual basis, is often more than 300 percent.

Payday Loan Risks

The danger of payday loans frequently arises when a borrower decides to extend the loan at the end of the original loan period. Refinancing the loan every two or four weeks is convenient, but a $200 payday loan can quickly become a $1,000 debt and a great deal of financial difficulty.

Using Payday Loans Wisely

If you’re very careful, you can use a payday loan to wisely deal with true emergencies. If you’re in danger of losing your job because you can’t get to work, getting your car fixed qualifies as a reason to get a payday loan. Paying for a new sound system or a special paint job for your car doesn’t. Commit to paying off the loan with your next paycheck, rather than extending it for another few weeks.

Carefully investigate the interest rate a lender will charge before you agree to a payday loan. You’ll need to be willing to read the fine print to determine this. Be aware of extra charges. For example, many payday loan companies charge extra fees if you choose to extend a loan past its original deadline.

Conclusion

If you have no other options at all, a payday loan can get you through a short-term financial emergency. However, depending on a payday loan to finance items you want but don’t need or regularly make up for budget shortfalls is a big mistake.