What Are Payday Loans And Why Are They Bad?

If you’ve ever needed cash on short notice you may have considered a payday loan. While payday loans were originally meant to help make ends meet on occasion, they can easily trap borrowers into an endless cycle of debt. This post details everything you need to know about payday loans, and how to stay clear of payday debt.

What is a payday loan?

A payday loan is a short-term, high interest loan for a small amount that is usually due on a borrower’s next paycheck, hence the name. No credit check is required – the only requirements are typically income and a bank account.

Payday loans are also often called cash advances, installment loans, and deferred deposit loans.

Getting a payday loan is extremely easy. Simply walk into a store or visit a website, verify that you have income and a bank account, and the lender will give you the money. Typically you will either receive a cash or direct deposit right away. Sometimes, a lender will require you to write a post-dated check for when the loan is due.

Most of the time, the loan is due within 14 days, plus a finance charge, which is effectively interest. However, if you aren’t able to pay back the loan on the due date, that’s when things get ugly.

Why are payday loans bad?

In theory, there is nothing wrong with a short term loan to make ends meet. However, in practice, the industry is deceptive and predatory, and lures unsuspecting consumers into a financial trap.

What happens when you don’t pay back the loan on time

If you don’t pay back the loan on-time, things can get real ugly, real fast.

Typically you will not only pay the interest, but an additional late fee. This goes on your balance. Then, you start having to pay interest on that balance. If you don’t pay on the next payday, more fees and more interest.

And guess what? You have to pay interest on your interest.

Just how high are the interest rates?

Extremely high interest rates

Payday loans average around 400% annual percentage interest rates. By comparison, credit cards rarely charge higher than 30% APRs.

This is why the average payday borrower ends up spending $520 in fees just to borrow $375.

The industry is known for predatory lending – signing up consumers with the intention of getting them entrapped into debt. In fact, theres a term for this: the payday loan trap.

The payday loan trap

Most people who take out a payday loan aren’t in the greatest spot financially – otherwise they wouldn’t be looking for a payday loan.

However, lenders know this, and intentionally make language confusing and misleading. It’s in their best interest for you to miss your payments and accumulate debt. They’re literally banking on borrowers not being able to pay.

Very quickly, borrowers find themselves accumulating more loan than they are able to pay off. And this is why it’s called the payday loan trap.

The legality of payday loans

Though there is some Federal regulation of payday loans, they are primarily regulated at the state level. Payday lending is completely legal in 27 states, with 9 additional states allowing some restricted, storefront lending. Payday lending is completely illegal in 14 states and the District of Columbia.

Most states that allow payday lending have some sort of regulation around the number of loans, loan amount, interest rates and loan terms.

At the federal level, payday lending is regulated by the Consumer Financial Protection Bureau.

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