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Advantages and Disadvantages of Payday Loans

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Advantages and Disadvantages of Payday Loans

Like all financial instruments, payday loans have their advantages and disadvantages. Let’s look at both.

Things To Know

  • You can get a payday loan even if your credit is bad.
  • Payday loan rates reach 500% when calculated over a year, and sometimes much more.

Advantages: why do people choose payday loans?

Payday loans are popular for many reasons:

  • Convenience: You can get a loan in just a few minutes, either as a check or as a deposit in your checking account. You can even get one online. You must provide identification, proof of income, a bank statement, and a personal check.
  • Low-income people can get them: Payday loans are available to those with low incomes.
  • Poor credit? Not a problem: Typically, you can get a loan even if your credit is bad. Many people who take out these loans already have bad credit.
  • No restrictions on what you can spend it on: Once you’ve got your money, you can spend it on whatever you want.
  • You can use the cash right away: Once the money is handed to you, you can use it immediately. In contrast, regular bank loans take days or weeks to be available to you.

What are the disadvantages?

Few things beat the allure of fast, easy cash. But let’s look at the potential downsides of that fast, easy cash.

  • Two weeks might be too soon: What happens when payday arrives and your loan is due to swallow up all or part of your paycheck? If you’re like most people, you need that money for something: rent, the electric bill, car repairs, food for the kids, medicine for the elders, or lots of other things. Will your paycheck cover those things? If you are already low-income, then perhaps not. You might feel compelled to extend the loan or take out a different one.
  • The costs: The chief disadvantage of payday loans is the interest you must pay. Those rates reach 500% when calculated over a year, and sometimes much more. The lender may also charge administrative and loan fees, adding to the cost of the payday loan. And if you can’t pay the loan back on time, you will be charged late fees, which can be very high. The high interest rates on a payday loan make it very difficult for some borrowers to repay the loan when it comes due at the next paycheck, so they end up borrowing more money, paying more interest, and getting more deeply in debt, setting up a cycle of debt that is very difficult to break. Note: Not all states allow such high interest rates, and the legal issues around payday loans do change over time. Some states have capped interest rates at lower levels.
  • They might not help your credit score: When you use a credit card, your credit activity gets reported to the three big credit bureaus. Payday loans do not. This may seem like a good thing to some people, but remember that it is important for everyone to build up a good credit score. Even the wealthy need good credit scores.
  • Lenders might be unscrupulous: Although payday lending is regulated by law, there are many shady lenders who use sham transactions or illegal setups to get around state laws.