Many families turn to "payday loans" (short-term loans for small amounts) as a quick fix to get out of a sticky financial situation (or to afford more gifts for Christmas, perhaps?) However, these loans can be very dangerous, locking you into a vicious debt cycle.
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There are times when a payday loan might be the only thing standing between yourself and eviction, or when you may be tempted to turn to it for an emergency expense. By and large, however, taking out a payday loan is simply not a good idea. Even in an emergency, it can be wiser to spend a month living with relatives as you look for a new place than it is to take out a payday loan. Here's what you need to know:
It's More Expensive Than You Think
The cap for a payday loan's interest rate in some areas runs as high as 60%. That's astronomically high. This means that to take out a $1,000 loan, you might wind up paying back $1,600. No Christmas present is worth a 60% gratuity.
Add on to this the fees, which are not included in the interest rate.
Admin fees, collection fees, even early repayment fees can rack up to a maximum of $23 for every $100, depending on where you live. This means that a payday loan, with interest and fees, can cost you up to 183% of the amount borrowed, so a loan of $1,000 might wind up costing you $1,830, almost twice what you originally borrowed.
But wait, that's not all.
So you've just taken out a payday loan to make rent and bills. Now you have to come up with another grand and another five hundred dollars on top of it. You simply can't pay off your loan and make rent this month, so what do you do? Take out another loan. Now you're another five hundred in the hole. A thousand dollar loan has cost you two grand, and obviously you can't make rent next month without a loan, either.
One payday loan can start a cycle that keeps you in a hole that keeps getting deeper and deeper every time you try to dig yourself out of it.
For the lender, it's a perfect business model. Advertise your service as a way out for desperate people, people who are scared and perhaps not thinking clearly about their finances, and trap them into a cycle of borrowing that is nearly impossible to break.
There are plenty of alternatives to taking out a payday loan. You can move to a smaller apartment with lower rent. You can have a modest Christmas and make up for it on birthdays. You can pay the late fees to the utility companies, because they're almost invariably going to cut you a better deal than a payday lender will. Keeping an emergency fund is a good idea, but if you're already in the hole, then it's an idea that you'll have to file away for later.
Are there exceptions? Sure, but the bottom line is that it's almost never a good idea to take out a payday loan.