Payday Loans: Pros, Cons, Risks and Costs
Cash advances serve a purpose, and can be very helpful to people who
need them in an emergency situation. They are granted
when you write a post-dated check and a promissory note. The check you write is deposited
by the lender on your next payday. For many, these loans help them
get by until the next payday and typically cover emergency expenses, such
as an emergency airline ticket, car repairs, or to cover unforeseen bills. In this article, we discuss some of the pros and cons of cash advances, and reiterate their costs and risks.
What are Payday Loans?
Payday loans are small loans, usually under $1,000, that normally do not require credit checks or exhaustive underwriting requirements. The lender does require an identity confirmation, so you are required to provide your Social Security Number on your loan request. A "soft inquiry" to the credit bureau can allow the lender to verify your identity, but soft inquiries do not harm your credit rating. The lender must protect their assets and consumers, by verifying that applicants are who they say they are.
How Do They Work?
To get a payday loan, the borrower gives a payday lender a postdated personal check, or an authorization for automatic withdrawal from the borrower's bank account. In return, she receives cash, minus the lender's fee. When the payday loan due date arrives the lender cashes the borrower’s check, which repays the loan in full.
For instance, with a $500 payday loan, a borrower pays a fee of approximately $100, and would therefore get approximately $400 in cash ($500 - $100 = $400). The lender holds the borrower’s check for a short period of time, usually until the borrower’s next payday, or at most a few weeks. At that time, the loan is due and must be paid in full. If the borrower does not have the expected money in her account she may be able to extend the payday loan, but will usually be required to pay an additional fee to do so.
Who Uses Them?
Most users of payday loans are those with an inability to get conventional credit, such as a personal loan or a real estate secured loan. Although payday loans are expensive, they are quite convenient. Therefore, they are a popular choice for people requiring immediate cash for a variety of reasons, especially to cover emergency expenses. For many people, bad credit loans provide the immediate cash they need to get by until the next payday, and typically cover emergency expenses, such as an emergency airline ticket, possible bounced checks, or to cover unforeseen bills.
How Can You Obtain a Payday Loan?
You can apply for a payday loan in person at a physical check-cashing facility or online. Applying in person offers one distinct advantage: you can get cash in just a few minutes. When applying for cash advances online you can expect your account to be credited within 24 to 48 hours.
There are three primary underwriting criteria for a payday loan:
- Proof of a regular source of income, like a steady job, or recurring payment source
- A checking account
- A valid government issued form of identification, usually a driver’s license or passport
It’s obvious from the lack of documentation required to underwrite a payday loan that it is significantly easier to obtain than a conventional personal loan, especially for those with credit blemishes, since credit score and past credit history are not a factor in being approved for a payday loan.
The Dangers of Cash Advances
Even though a credit check is not required for a payday loan, don't be surprised when the lender asks for your Social Security Number. As we stated above, this is necessary to verify your identity, and could be used to report to the credit bureaus in case of a default on your loan.
If your check to the payday loaner were to bounce or is otherwise invalid, you are charged a bounced-check fee, which over time can add up in additional fees from the lender and your bank. Be mindful of payday loan due dates as you do not want to accumulate bounce check fees, overdraft fees, or payday loan extension fees.
Expensive, but Cheaper than Overdraft Fees:
Although payday loans
are quite convenient, they are expensive. Their high costs are justified by the risk posed to the lender, and the convenience provided to the consumer. A recent study showed that payday loans are cheaper than bank overdraft fees, The study stated that "a typical NSF check can result in overdraft fees and interest in excess of 3,500% APR." The typical payday loan costs an about 300%, so again, they are a matter of convenience if you face an emergency, and need immediate funds and lack sufficient cash in your checking account. If you are at risk of bouncing checks, a payday loan can be cheaper than the costs of overdraft fees.
Use Them Wisely!
The
best advice we can give, is to use these loans very sparingly. They
come with very high fees, and
you run the risk of becoming dependent on these loans. If used too frequently, you may
find yourself living paycheck to paycheck.
If you default, the loans may be referred
to a collection agency and will likely be reported to the credit
bureaus. However, some lenders offer flexible payback options, which is convenient, but costly. If you are interested in flexible payback programs, be sure to ask your lender if they offer this service.
So, all-in-all, these loans are a convenient way to get cash when you need it, but we definitely
caution against excessive use and dependency. Comparing between different payday loans companies,
you can find many with competitive interest rates
and make a smart decision to get cash in advance
but not ending up with a big financial mess.
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