More than half of Americans and three-quarters of Canadians take out loans at some point in their lives. Among the most common reasons for this are financial emergencies (such as medical expenses and home repairs) and large investments like cars, homes, and businesses.
There are numerous types of loans, many of which serve one specific purpose. Payday loans are among the easiest to obtain, but they come with huge costs that most who use them aren’t prepared for. In this article, we’ll tell you everything you need to know about payday loans to help you know when to use them, and when to avoid them.
What is a payday loan?
A payday loan is a short-term loan that usually lasts up to two weeks (or until the borrower’s next paycheck, hence the name). It is considered high-risk because it comes with astronomically high interest rates (typically 400%) and fees, making repayment difficult.
The appeal of taking out a payday loan lies in its quickness and ease of use. It doesn’t require a credit check, and the loan can be deposited directly into your bank account within 24 hours.
Most loans, including those issued by banks, credit unions, and other financial institutions, are based on a borrower’s credit score and entail long approval processes. Payday loans are often seen as the only option for those without good credit, a strong financial history, or time to wait around.
Why People Use Payday Loans
People take out payday loans when they’re severely limited on time, or they don’t have access to the same credit options as those with a good financial standing. People primarily use payday loans to:
- Cover emergency expenses like medical bills, car repairs, or home repairs
- Pay for large purchases that can’t be covered by other forms of credit
- Make ends meet (pay rent or phone bill, buy groceries) before they receive their end-of-month paycheck
Those with bad credit also use payday loans because it’s the only way they can get approved for a loan; most financial institutions require a credit score of at least 610 to qualify.
When to Use Payday Loans
Payday loans are best used as a last resort and should never be taken out without thoroughly researching the company and its terms. If you’re considering taking out a payday loan, be sure that:
- You have no other options available (asking family/friends for help, taking out a longer-term loan with lower interest rates)
- You understand the terms of the loan and won’t be charged additional fees
- You have enough money to repay the loan on time
- You will have enough money to cover the high interest rate
- The terms of your repayment are non-negotiable (such as a rent payment that will otherwise result in eviction)
- You have no other sources of funding and your financial need is immediate
When to Avoid Payday Loans
Payday loans should generally be avoided whenever possible. They come with extremely high interest rates that can easily spiral out of control if you cannot pay back the loan on time.
It’s also important to remember that most payday loans are short-term, meaning they need to be repaid in full within two weeks. Given the typical rate of 400%, you’d need to pay $4,000 on a $1,000 loan in just two weeks’ time.
If you’re even the least bit anxious about your finances, a payday loan will only add fuel to the fire unless you know you’ll have a large amount of liquid cash in the near-immediate future. It’s important to remember that taking out a loan is rarely the answer. Instead, focus on creating an emergency fund, budgeting, and saving money.
Alternatives to Payday Loans
The reality is most people have alternatives to payday loans that are not only safer, but also much less expensive. Some ways to access cash without taking out a payday loan include:
- Credit cards: Credit cards offer considerably lower interest rates (and usually more flexible repayment terms) than payday loans.
- Personal installment loans: Personal installment loans come in all shapes and sizes, from short-term to long-term. As long as you have good credit, they’re much cheaper than payday loans and can help with large purchases.
- Family or friends: If your financial situation is dire, consider asking family or friends for help before turning to lenders.
- Crowdfunding: Crowdfunding websites like GoFundMe and Kickstarter allow you to reach out to a wider audience, potentially raising money to help pay for an emergency expense.
- Working with your creditors: If you truly can’t find another way to cover your bills, contact your creditors directly and explain the situation. Assuming your inability to pay bills on-time hasn’t been a major problem historically, most will be happy to work out a payment plan that fits your budget.
Tips for Taking Out Payday Loans
If you decide a payday loan is ideal for your situation, working with a reputable company like My Canada Payday is your best bet; many payday loan companies are borderline predatory, so it’s important to stick with a trusted lender. Here are a few other essential tips:
- Read the terms and conditions thoroughly to understand all of your rights and responsibilities
- Know when your balance must be paid in full (usually within two weeks)
- Be prepared for steep interest rates that’ll add up quickly if you don’t pay back on time
- Avoid extending or rolling over the loan, as you’ll be hit with additional fees
- Don’t use your payday loan to pay for something “frivolous” like a trip or shopping spree
- Do not take out multiple payday loans simultaneously
Endnote
Payday loans can be incredibly helpful in a pinch, but they also come with hefty costs you need to consider. Before committing to a payday loan, make sure you understand the terms and conditions of the loan, all of your alternatives, and how you’ll pay it back on time. If there’s any doubt about your ability to make the payments, it’s best to avoid payday loans altogether.