Payday loans are a type of loan that can be a financial lifesaver in an emergency, but they can also be a financial quicksand if you're not careful. Before taking advantage of that fast and very expensive money, it's important to understand what payday loans entail. High interest rates and hidden fees can quickly ruin your financial health and credit rating. So why are payday loan rates so high? The answer lies in the commission-based structure. As Bennett points out, the short-term nature of these loans makes them more expensive compared to other types of loans.
Many payday borrowers end up accumulating their balances because they can't cover the full amount when it's due, and these charges can add up quickly. To determine your rate and terms, the payday lender may request a credit check to see your credit score, although this is less common with payday loans. Fast loans are marketed as a way to get “quick money” for emergencies or to meet short-term needs, but many people use them over and over again to compensate for cash shortages. Hence the name. Generally, they must be repaid (plus fees) before the borrower's next payday after the loan is granted.
While some payday lenders don't report directly to the three major credit reporting agencies in the United States, most report to smaller agencies. If you can't repay the loans (and the Consumer Financial Protection Office states that 80% of payday loans aren't repaid in two weeks), the interest rate skyrockets and the amount you owe increases, making it nearly impossible to pay them off. However, many states have laws that limit the fees or interest rates payday lenders can charge, and others have completely banned payday loans. A quick loan won't negatively affect your credit if your payday lender doesn't require a thorough credit check and you can repay the full amount before the required date. Payday lenders take advantage of people in desperate economic situations, namely, low-income families, minority families, members of the military, and anyone else with limited credit options. Among other details, the rules for repeating loans, waiting periods between loans, and loan limits vary from state to state. Another penalty that consumers often incur with payday loans is the lack of sufficient funds (returned checks) from their bank.
They may be the only source of lending available to people with low credit ratings and those who can't get traditional loans. In addition, the likelihood of default on payday loans is quite high and it would be better to use an alternative funding source to overcome a financial problem. Up to 12 million Americans use payday loans each year, according to extensive research by the Pew Charitable Trusts. So while they may be a lifesaver in an emergency situation, it's important to understand how expensive they can be and how quickly they can spiral out of control if you're not careful.