Payday Loans: Risks, Alternatives, and When They Might Be Necessary

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Payday loans have extremely high interest rates -- but is it ever OK to take one out? Find out the answer here.

Payday loans are short-term loans with very high interest rates. In fact, the Consumer Financial Protection Bureau (CFPB) warns payday loans usually charge an APR of around 400%. Unfortunately, because the costs of payday loans are typically represented as fees you pay to borrow, many people don’t realize how high the effective interest rate is.

When you’re borrowing money at such a high cost, it can be almost impossible to pay back what you owe and stay out of debt. If you take a $100 loan with a $30 fee and you have to pay back $130 next payday, you may have a hard time coming up with the cash. And if you do pay it back, you may run out of money again before you get your next paycheck, necessitating that you take another payday loan.

Because of the huge expense and short repayment timeline of payday loans, many people end up having to take out another payday loan to repay their initial loan on time. This can keep happening over and over, until you become trapped in a cycle where you almost constantly have at least one payday loan.

Obviously, all of this means taking out a payday loan is very bad for your finances. In fact, the decision to take out a payday loan can have financial consequences that reverberate throughout your life for months and that even put you on the path to bankruptcy if you can’t break the borrowing cycle.

With that said, you may be wondering if there are ever any circumstances where it’s OK to take out a payday loan. This guide will help you decide.

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Explore all of your other alternatives before you take out a payday loan

Before you even consider a payday loan, you need to explore every other alternative first, as almost all other types of borrowing will likely end up costing you less than a payday loan. Some of the other kinds of financing you should consider include:

• Payday alternative loans: These are short-term loans available to credit union members who need speedy access to small amounts of cash. Fees are capped and you’re limited in how many payday alternative loans you can take out per year. These loans are much more affordable and are a way better way to borrow than payday loans if you have a short-term financial need.
• Credit cards: If you can use a credit card to pay for your essential purchases instead of a payday loan, you’re better off. In most cases, this is true even if you end up having to take a cash advance from your credit card -- although cash advances come with higher fees and a higher APR than standard purchases on most cards. It’s true credit card interest is very expensive, but the interest you’ll pay on a card isn’t even close to what you’d have to pay on most payday loans.
• Personal loans: Personal loans have lower interest rates in most situations than payday loans or credit cards, and they can also provide a set repayment timeline. If you can pay off your personal loan on a fixed schedule with an affordable monthly payment, this is far better than being forced to repeatedly take out payday loans. It can also be better than getting stuck with credit card debt at a higher interest rate that you could be paying for decades if you pay only the minimums.

You should also consider borrowing from friends and family, selling items you don’t really need, picking up a side hustle temporarily, and exploring all other possible sources of funding before taking a payday loan. For example, if you think you need a payday loan to cover an essential medical bill when you take your sick child to the doctor, you should first talk to your care provider about whether you might be eligible for a payment plan.

What if you’ve exhausted all other alternatives?

If you have absolutely no other way to come up with money and it is completely imperative you have cash available to you, a payday loan could be your best and only option. But you should go into the transaction with eyes wide open and an awareness of what a dire financial move you’re making.

Payday loans shouldn’t be used to cover things that aren’t real, true emergencies. For example, if you need a payday loan to cover a car repair because you absolutely must have a vehicle or you’ll lose your job, it may make sense to take out the payday loan. Yes, it will make your financial situation worse temporarily -- but the consequences won’t be as dire as the loss of your job might be.

You do, however, have to consider whether a payday loan will actually provide a long-term fix or whether you’re only delaying bigger problems. If you’re about to be evicted and considering a payday loan to pay your rent, think about whether the loan will actually help you keep your home. If your payday loan could cover your rent for one month but it will still be impossible for you to cover rent next month, you’d just wind up evicted anyway -- and then you’d be without your home and more deeply in debt. As long as you have somewhere else to go, taking the payday loan may not be worth the one month reprieve.

Payday loans are always a bad way to borrow

To recap: The only situation where this type of borrowing might make sense is if you have no other alternatives at all, a payday loan is the only way to avoid worse financial disaster, and you aren’t just delaying the inevitable with a payday loan. In all other situations, you should look for a more affordable financing solution -- or avoid borrowing period if you can’t find a cost-effective way to do so and the debt will only make your finances worse in the long run.

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