Should Payday Loans Be Avoided?

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Should Payday Loans Be Avoided?

Whether you should avoid payday loans is a matter of debate. But given their high fees, it is worth looking at how they can affect your financial life and whether there are alternatives that you could consider.

How may they affect your credit and your finances?

The three big credit reporting agencies—Equifax, Experian, and TransUnion—generally don’t put payday loans (or defaults either) on credit reports. But there are other, smaller credit reporting agencies out there that do, and it is possible that someone pulling your credit report for a job or a loan might see those. Also, remember that if you don’t pay your loan back and the payday lender turns the loan over to a debt collector, that action may show up on your credit report. Then there is the possibility that the lender will sue you if you don’t pay back your loan, and if you lose that lawsuit, it will show up on your credit report.

If you are not careful, using payday loans can affect not only your credit, but your finances in general. If you have done the math, you can see how all that money going to pay off the interest and fees on the loan could have gone to other uses—such as investments that could earn more money for you. In worst-case scenarios of your finances suffering, your relationships could suffer, you could be evicted from an apartment, or you could be denied credit.

There is also the matter of title loans. These are payday loans for which you put up collateral, such as a car. If you defaulted on your loan and the lender repossessed your car, that could affect your ability to go to work and earn money.

There are alternatives

There are alternatives to payday loans if you are in a financial crunch:

• Your bank or credit union. Many credit unions offer small emergency loans at interest rates much, much, much lower than payday lenders. Some banks also have similar programs. And the payback period can be stretched several months. As well, these institutions offer personal loans, though they will require you to put up some collateral as security. As a rule, banks and credit unions will always have more resources for you.
• Credit cards. You may also be able to get a cash advance from a credit card. While those interest rates will be high, they are not as high as that of a payday loan.
• Friends and family. Can you borrow money from a family member or friend?
• Overdraft protection. Find out if you can get overdraft protection on your checking account. Overdraft protection is basically a short-term loan. There will be fees for this service, but they will be lower than those of payday loans.
• Communicate with your creditors. Many of us hate to do this. But if you are in danger of missing payments on a non-payday loan (credit card, auto loan, etc.), contact the people in charge of it to work out a payment plan. Most of them would rather work with you in some way than have to sell your loan to a debt collector and not get much in return. That way, you can avoid having to take out a payday loan to cover it.
• An advance from your employer. Some employers may be open to this.
• Credit counseling. If your problem is that you are in too much debt or overwhelmed by bills, credit counseling can help. An accredited non-profit credit counselor can help you work out a payment plan with your creditors to get you on a sustainable financial footing.

Some final thoughts

The Federal Trade Commission (www.ftc.gov/) and the Consumer Financial Protection Bureau (www.consumerfinance.gov/) monitor the activities of payday lenders. Over the years, the federal government has reined in lenders’ activities in an effort to prevent illegal and unethical practices. Some advocates are calling for a smaller interest rate and a requirement that lenders also consider borrowers’ income and expenses to determine whether they can repay their loan without re-borrowing. A rule change at the Consumer Financial Protection Bureau in 2020 established that lenders will not have to check that borrowers can repay their loans when they come due.

So, should you avoid payday loans? It’s up to you, of course. Some borrowers defend them. Most counselors and community leaders would recommend avoiding them, given their costs and the availability of alternatives.