What is the Biggest Disadvantage to a Payday Loan? With Solution and Real Example
- Published on -
- Written By - Alex Hales
- Reviewed By - Zack M. Disette
- Research indicates that the primary disadvantage of a payday loan is getting into a debt spiral, where a borrower rolls over loans time and again, resulting in mounting debt and deterioration of the financial situation.
- Clearly, very few people, if any, would be able to pay off their loans at an interest rate of over 400% APR, which is extremely common for these loans.
- The tendency is to assume that payday loans are aimed at the already vulnerable segments of society, worsening their already frail financial circumstances.
- Studies conducted by CFPA show that 80% of people who take out payday loans only do so repeatedly in less than a month’s period.
1. Sudden Drop of Interest (APRs That Leave You Shook)
The Problem: Payday loans often come equipped with APRs over 400%. Borrowing 500 could cost you575 in two weeks, a horrific 391% APR over a year.
The Solution:
- Credit Union PALs: For Credit Union members, a Payday Alternative Loan (PAL) can be obtained, set to a reasonable 28% APR cap.
- Bill Negotiations: Reach out to creditors for direct payment plans for bills, many hospitals or even utility companies do offer these interest-free.
- Side jobs: Utilize apps for quick routes to money without loaning them anything in return.
2. The Trap of Debt Cycles (The Power of Borrowing to Repay Borrowing)
The Problem: New loans fueling over 80% of payday loans adds these borrowers into a recuring cycle always revolving around them.
The Solution:
- Debt Snowball Method: Paying off smaller debts first helps to maintain motivation.
- Nonprofit Counseling: Specialized groups like the NFCC provide free services for debt management.
- Emergency Fund: Begin by saving $500 to stop the needless dependency on loans.
3. Very Short Repayment Term (Two Weeks? Yes, you heard right.)
The Problem: If you have to pay off loans in full within a pay period, you have no time to recuperate.
The Solution:
- Installment Loans: Choose lower monthly payments over shorter-term loans.
- Extended Payment Plans (EPPs): In certain states, lenders are required by law to provide EPPs at no additional cost.
4. Relocation of Negative Balance (Automatic Shifting of Fees)
The Problem: It’s not just late charges, origination fees, and rollover payments that will instantly put you in double debts.
The Solution:
- Demand A Fee Schedule: Lenders should be asked for a documentation that encompasses and explains the fees they invoke.
- Apps to the Rescue: Monitor fees and deadlines with Truebill or Mint.
5. Overdraft Domino Effect (Bank Fees Piling Up)
The Problem: Unauthorized automatic withdrawals lead to overdraft fees, which increase your debt.
The Solution:
- Separate Bank Account: Tie the loan to an account that has the minimal required balance.
- Opt Out of Overdraft: If you choose not to have overdraft protection, the bank will be unable to charge fees.
6. Damaged Credit Collateral Costs
The Problem: Both defaulting and making timely payments negatively impact one’s credit score.
The Solution:
- Credit-Builder Loans: Self Lender and other similar products report payments to the bureaus.
- Prioritize On-Time Payments: Print calendar alerts on your computer to remind you of upcoming payments to avoid defaults.
7. Lending Abuses (Exploiting Those In Need)
The Problem: Exploitive lending practices are common in lower income areas where fraudulently enticing deals are made.
The Solution:
- Check Lender’s Licenses: Search the local financial body registries of your state.
- Complain: Use the CFPB or FTC to file reports.
8. Overzealous Debt Collectors
The Problem: Divisive calls, threats, and embarrassment are some of the methods employed commonly used.
The Solution:
- Rights: The FDCPA allows you to silence the collectors and guarantees you are not threatened or called before 9 p.m.
- Capture Everything: Bring forth the lawsuit for violations. Collecting documentation may earn you upwards of 1000 dollars.
9. Minimum Borrowing Quantities (Covering Up a Gunshot Wound)
The Problem: As is most often the case, payday loans do not exceed a grand and pinch a lot harder than they help.
The Solution:
- Individual Loans: Specialized financial institutions, such as Upstart, offer over fifty grand under appropriate conditions.
- Help from the Public: Nonprofit and religious organizations frequently aid in great emergencies.
10. Psychological Impact (Stress, Shame, and Anxiety)
The Problem: The form of financial pressure is so incessant it makes sleeping a challenge, decreases productivity, and causes one to feel shameful.
The solution:
- Free Counseling: You can get therapy from Open Path and 7 Cups.
- Social Networks: Talk to your friends, they can help, and you are not alone.
Example Scenario:
Think about a borrower that takes a $500 loan, plus a $75 fee, now owing $575 and due within two weeks.
If they can’t pay it, they have to roll it over, but now the total is $650 and they are also paying an extra $75. The debt rises to around $725, then $800, and continues going up, ultimately extremely over the amount loaned.
This scenario is based on reality, demonstrating just how instantaneously the debt cycle can grow, ensnaring borrowers in a financial mess.
Data Points Underlining the Problems Associated With Payday Loans
- High Expenses to Loan Ratio: Every year, 12 million people in the United States take out payday loans at a cost of $9 billion in fees. The average fee for a borrower amounts to $520 while the borrower initially takes a loan of $375; this illustrates that fees often exceed the payday loan.
- Prolonged Debt: A borrower of a payday loan has an outstanding loan for 5 months of the year, which is a five month period of time due to the expensive nature of these loans.
- Overlapping Loans: Within a period of 14 days, more than 80% of payday loans are either renewed or followed with a new loan, showcasing that majority of borrowers are unable to pay off their loans fully by the deadline.
- Vulnerable Demographics: Renters, African Americans, aged 25-44, parents with under-age children, and individuals making north of $40,000 a year single handedly comprise the bulk of payday loans.
Pay Day Loan Alternatives
In light of these issues, the following options are recommendable:
- Asking friends or family for a loan, although this can create tension.
- Instead, going to credit unions that provide small loans at a relatively lower cost (Credit Union Options).
For example, interest-free advances for eligible recipients of Centrelink, which is the Australian Government Services program (Australian Options).
Final Thoughts:
Payday loans might provide quick solutions but can put cash-strapped borrowers under a debt cycle at a higher risk. Knowing these risks is crucial to mitigating financial damage and encouraging a better life for vulnerable borrowers in the long term.
