Should You Ever Take a Payday Loan?

Payday loans have many names -- cash advances, signature loans and paycheck loans, etc. Payday lenders provide quick and easy short-term cash to those who need money immediately. That's the big reason why they're so popular.

However, payday loans come at exorbitant costs. This can -- and often does -- lead borrowers into a downward spiral of rapidly escalating debt. Let's look at the issue from various angles to get a complete picture.

First, the pluses. Here's why cash advances may hold enormous appeal for you.

• You can have bad credit and still qualify for a payday loan. In most cases, no credit check is conducted.
• The process is fast -- it takes as little as 20 minutes to complete. You can even find lenders who target approvals in 30 seconds!
• There are no upfront costs -- so the buy-now-pay-later mentality can find full expression.
• You can apply in person at a local outlet, over the phone or over the Internet.
• You get funds deposited into your bank account in 24 hours.
• Compared to some other sources for cash, payday loans are discreet -- no one else needs to know about it.
• The transactions are secure -- your financial information remains private.

If you're faced with an emergency -- say, unexpected medical bills -- your only consideration might be to get money now. The speed and convenience of a cash advance comes in handy here.

So what are the disadvantages?

The most obvious one -- high costs. A payday loan can cost you say, $15 per two weeks. If you're borrowing only for two weeks, that doesn't sound like much. However, if you calculate the Annual Percentage Rate (APR), you'll see it comes to 391%!

If you don't think that's too much, let me ask you this question. If you invested money in the stock market, what would you consider a good annual rate of return? 20%? Maybe 30%? If you made a 20% return (on average) in stocks year after year, you'd be doing very well indeed. And this is for an investment that's generally considered high risk.

Now compare that with what the payday loan companies charge. You are providing them with a return on their money they likely won't get anywhere else on the planet!

There is another, less obvious reason why payday loans are dangerous. According to some estimates, over 60% of borrowers roll over a payday loan. Many take loans repeatedly, too.

Let's put in some numbers so that you can clearly see what rollovers imply.

Assume you borrow $400 for two weeks at a cost of $15 per $100 per two weeks. At the end of two weeks, you owe them a total of $460.

Let's say you don't repay the $400 at the end of two weeks. Instead, you request a rollover. So you pay them the lending fee of $60 and they agree to roll over the loan for another two weeks. The total cost of the loan at the end of 4 weeks may be as follows:

Original loan amount: $400
Fresh lending fees payable: $60
Late fees payable: $60 (assuming late fees apply at the same rate as lending fees)
Lending fees already paid: $60
Total: $580

At the end of this period (which is 4 weeks from the day you originally took the loan), you decide that you don't have $580 available and so request them to roll the loan over for another two weeks. Then this is what it can cost you in total at the end of 6 weeks:

Original loan amount: $400
Fresh lending fees payable: $60
Late fees payable: $60
Lending fees already paid: $120
Late fees already paid: $60
Total: $700

If you continue this process for six months (more specifically, for 24 weeks), this is what it may cost you in total:

Original loan amount: $400
Fresh lending fees payable: $60
Late fees payable: $60
Lending fees already paid: $660
Late fees already paid: $600
Total: $1780

For an original loan of $400, in a mere 6 months, the payday loan company will collect fees and charges of $1380 from you. That's 3.45 times the amount you borrowed. In APR terms that's 749.5%! If over 60% of borrowers roll over their loans, no wonder many payday loan companies are wildly profitable!

Snowballing costs can easily lead you into a debt trap if you get addicted to payday loans.

So what are the key points to keep in mind when dealing with payday loan companies? Two things:

First, avoid them if at all possible. The best way is, of course, to get your finances fully under control so that you always have cash and / or credit available to meet emergencies.

Second, if you do choose to borrow from payday loan companies, borrow only an amount you're 100% sure you can repay on the due date. If that amount is too low to meet your needs, get additional funding from other sources. Because rolling over cash advances is one of the worst things you can do to yourself.

About the Author

Prakash Menon is a financial expert and writer specializing in managing personal debt and providing wealth building solutions. He has written articles on cash advances, personal debt management and other topics.

Wall Street Journal Blogs

December 22 Is Deadline to Apply for SBA Economic Injury Disaster ... MarketWatch - 15 hours ago The deadline to file applications for Economic Injury Disaster Loans (EIDLs) is December 22, 2008. Small businesses and small agricultural cooperatives that ... Small business loans dwindle The Tennessean Loans available for September storm damage Columbia Missourian Wells Fargo named top small-business lender in Texas Bizjournals.com Marshall County Journal - Salt Lake Tribune all 264 news articles

FHA-Backed Loans: The New Subprime BusinessWeek - 5 hours ago Washington, meanwhile, has vastly expanded the availability of such taxpayer-backed loans as part of the emergency campaign to rescue the country's swooning ... FHA lowers limits on loans Arizona Republic FHA Relaxes Program Rules for Homeowners Washington Post all 3 news articles

Los Angeles Times

Hiccups appear in bank loans Burnet Bulletin, TX - Nov 19, 2008 7, depositors have not seen a change in their banking, but loan customers are confronting, in some cases, major problems. Those hurting, in particular, ... CORRECT: Modified mortgages often re-default MarketWatch Loan Modifications For Banks Could Mask Future Losses CNNMoney.com OUR VIEW: Mortgage relief grows Bristol Press New York Times - The Associated Press all 981 news articles

News 10 Now

Loans to Detroit Salt Lake Tribune, United States - 10 hours ago The debate in Congress over a bailout of GM, Ford and Chrysler comes down to this: Should the taxpayers throw $25 billion in bridge loans to Detroit, ... EDITORIAL: Loans OK if companies make major changes Trading Markets (press release) State car industry sees bridge loans as the road out Denver Post Big Three automakers scramble for aid MLive.com The Bay City Times - MLive.com - ABC News all 899 news articles

CMBS Market Begins to Show Fissures Wall Street Journal - 15 hours ago The rapid deterioration of these loans fed worries that the weakening economy and higher unemployment rate would drag down the $800 billion market for ... Big CMBS Loans Near Default; CMBX Soars, REITs Tank Seeking Alpha UPDATE 1-Big CMBS loans seen near default, index yields soar Reuters Commercial-Mortgage Bond Risk Rises After Loan Delinquencies Bloomberg Reuters - Wall Street Journal all 31 news articles

RTE.ie

IMF, Nordic Neighbors Agree Billion-Euro Loans for Iceland Deutsche Welle, Germany - 40 minutes ago Iceland's Nordic neighbors and the International Monetary Fund (IMF) have agreed loans of over two billion euros to keep the North Atlantic island nation ... led Iceland package to total $10.2 bln guardian.co.uk Iceland gets $2.1 billion loan from the IMF MarketWatch Nordic countries to lend Iceland 2.5 billion dollars: ministers AsiaOne The Press Association - International Business Times all 533 news articles

Calgary Herald

Ailing automakers plead for $25b in loans Boston Globe (registration), United States - Nov 18, 2008 The chief executives of Chrysler and Ford also pleaded for the loans, which would come on top of a $25 billion package approved in September to help the ... Auto Execs Reset Bailout Pitch; Republicans to Rewrite CAFE for Loans Ward's Auto (subscription) Big Three press bailout case for second day MarketWatch Hopes Dim for Quick Bailout for Automakers New York Times Oakland Press - New York Times all 2,711 news articles

Housing agency loosens foreclosure aid rules Reuters - 16 hours ago The Hope for Homeowners program will now insure home loans that have had as little as 3.5 percent of their value erased by the original lender. ... HUD Said to Entice Banks to Enter Foreclosure Program (Update1) Bloomberg US broadens rules for mortgage-aid plan Philadelphia Inquirer Government To Let More Homeowners Swap For More Affordable Loans KWTX BusinessWeek - Seattle Post Intelligencer all 84 news articles

Wachovia, Golden West Loans Probed by US Prosecutor (Update1) Bloomberg - 13 hours ago His office and SEC investigators in San Francisco are also scrutinizing whether the banks misled investors about the quality of Golden West's loans, ...

Pr. William Board Wants To Help Provide Loans Washington Post, United States - Nov 18, 2008 The Board of County Supervisors agreed in principle to make loans available to county employees, many of whom drive long distances to work because they ...