Many websites display advertisements for convenient “payday” or “cash advance” loans. The principal behind these loans is to advance consumers anywhere from $200 – $1,000 to get through a rough financial patch until the next payday. While the allure of these loans appeals to many a consumer, there are some things to consider before signing up for that personal bailout plan.
The interest rate on these loans is an astronomical 200 percent or more APR (annual percentage rate). With many of these companies, a consumer borrowing $200, end up paying back $225 or $250 several weeks later; all thanks to that annual percentage rate. It may not seem like a lot of money at the time, but the problem with these loans is that many consumers become chronically dependent on them. In fact, some people admit to taking out a new payday loan to pay off an existing payday loan, resulting $650 – $1,300 or more, in interest charges tossed away annually –based on a bi-weekly payment example.
($25 x 26 weeks = $650)
($50 x 26 weeks = $1,300)
Therein lies the debt trap. With cash advance or payday loans, the consumer is taking a big risk with his personal finances. First, he is risking not having the money to pay back the loan on the due date for a variety of circumstances, resulting in ever climbing interest rates and late fees. He is also risking added costs of refinancing the loan over and over again, becoming more like a hamster in a revolving wheel than a consumer. All of his disposable income is now eaten up in these interest rates and fees.
-What happens to your credit?
Part of the appeal of cash advance or payday loans is the fact that they are granted without a credit check. The lender doesn’t pull a credit history to approve the loan, and the loan doesn’t get reported on a credit history when it’s paid back. The only benefit to the consumer is temporary cash, accompanied by a high interest rate. These loans do not help build or establish credit, and with such a high cost to maintain, don’t make much financial sense.
However, if the consumer defaults on the loan, his credit report reflects that. In fact, a cash advance loan default is the only resulting impact to consumer credit reports. The defaulted cash advance or payday loan is put into collection after 30 days of non-payment, and immediately appears on a credit report, dropping scores substantially. Collection activities and negative credit consequences of a payday loan default follow a consumer for up to seven years; all the while accruing despicable amounts of interest and late fees in the process.
-Other, better options
The best option for cash strapped consumers is to keep a credit card on hand with a minimum $1,000 limit. For credit challenged consumers, a secured credit card with a deposit –and subsequent credit limit of $1,000-offers flexible repayment terms and far lower interest rates. Both options report payments to credit bureaus, ultimately helping your score.
However, the best solution overall is to have at least $1,000 liquid, in an emergency fund set aside in cash, avoiding interest payments and debt traps altogether.