People who are having trouble paying bills sometimes turn to payday loans to get the cash they need. Because these loans are very costly, it’s essential to understand how they work and how they can affect you before you decide to apply for one. Once you know the facts, you may find that there are better options available.
Writing the Check
When a consumer applies for a payday loan, she shows the lender proof of her income (like a pay stub) and selects the amount of money she wants to borrow. The Pew Charitable Trusts notes that the average amount of the loan is $375. The borrower then writes a check for that amount, plus interest, to be paid to the lender on the date of her next paycheck. Or she may sign other paperwork allowing the lender to withdraw the money from her bank account on that date.
The Loan Rolls Over
Within a few weeks, the loan comes due. Now, the lender tries to cash the check or withdraw the amount owed. In most cases, the borrower doesn’t have enough money to completely pay off the loan. Instead, she has to pay the lender a fee and postpone payment for a couple more weeks. And her bank is likely to charge her fees for the attempted withdrawal. This cycle usually repeats for several months before the borrower has enough money to pay the debt.
Why You Should Avoid Payday Loans
The Consumer Financial Protection Bureau points out that these loans usually carry an annual percentage rate of close to 400 percent. And that’s just the interest; the loans are even more expensive when you consider the renewal fees the borrower pays the lender each time the loan rolls over and the fees she pays her bank when the lender’s attempts to withdraw money are unsuccessful. The bottom line is that payday lending is very costly, and a small loan can quickly turn into a large one after interest and fees are applied. That’s why you should look for alternatives to payday loans, such as asking creditors for an extension or applying for a loan from a credit union, before you take out one of these loans.
Members of the Military
The short-term loans lenders offer to members of the military are different from the payday loans offered to the general public because the government regulates loans to service members. As the Federal Trade Commission explains, the annual percentage rate on short-term loans to service members is capped at 36 percent, and the lender can’t demand access to a checking account. Thus, members of the military aren’t subject to lenders’ attempted withdrawals from their bank accounts, and they aren’t charged the extremely high interest rates that apply to other borrowers. Still, 36 percent is higher than the annual percentage rate charged by credit unions and most credit card companies, so service members are also advised to avoid payday loans when possible. If you’re in the military and need a short-term loan, see if you can obtain financial help from a military aid society like Army Emergency Relief.
If you’re having trouble paying bills, there are alternatives to a payday loan, such as getting a regular loan from your local credit union or requesting an extension from the creditor.
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Consumer Education Services, Inc. (CESI) is a non-profit service provider of comprehensive personal financial education and solutions for all life stages and for all of life’s milestones. Our goal is enhanced economic security for everyone we serve.
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