Payday loans: Why they are bad and how to make the best of them

Almost everywhere you look these days you can find advertisements for payday loans.  And like other financial products, you can usually conclude that the more a product is advertised, the higher the profit margins it provides for the seller.  

Pay Day loans come under the guise of a variety of titles including; cash advance loans, check advance loans, quick cash loans, post-dated check loans, and deferred deposit check loans.  But no matter what they call it, the product is always essentially the same.  

What are Payday Loans

Payday loans are small quantity, short-term, high interest loans.  The way they typically work is that the borrower writes a personal check payable to the lender for the amount they desire to borrow plus the “loan fee”.  The lending company then gives the borrower the amount of the check minus the “loan fee” in cash.  So for example, if you wanted to borrow £100 for two weeks you might write a check for £115 and receive the £100 in cash.  

They are targeted towards those individuals who need a small amount of cash for a short period of time.  In theory they might be helpful for a family who, for example had an unexpected expense arise this month that they had to pay for right away.  This left the family short on funds to keep up with their regular obligations like rent and food.  This is the rationale behind the loans and it is the opportunity for individuals to get access to quick cash without the need for extensive credit checks that make the loan, on face value, seem worthwhile.

Why They Are Bad

The problem is in the details.  Returning to the example of the person who borrowed £100, let us now imagine that the two weeks are up.  And at the end of the term of the loan, the borrower must either “redeem” the check by paying the lender the £115 in cash or roll over the loan for another two weeks.  This adds another £15 pounds to the payment meaning that come two weeks later £130 is owed.  For those unfamiliar with the lending industry, this may not seem like a bad deal.  After all, the lender is taking quite a bit of risk, seeing as he hasn’t even checked your credit, right?

Well, not exactly.  The most insidious part of Payday loans is the amount of interest they bear.  A yearly home mortgage may be in the vicinity of 8%, while a Credit Card, which by most accounts verges on usury, charges in the vicinity of 30 – 40% in interest annually.  But comparing that to a Payday loan, which has an annual interest rate of 400 – 700%, is startling.

A Payday loan is one of the most expensive legal lines of credit that a person can procure.  On top of that, unlike a regular loan where if you default you can be hassled for late payments, a Pay Day loan company can by contrast simply deposit the check.  When it bounces you will have committed a prosecutable crime that the Payday Company can use as leverage to get you to pay at any cost.  In effect, they can threaten you, almost immediately, with criminal proceedings in a way that regular creditors cannot.

So why do Payday loans exist.  The cynic would simply say that they exist because the lending industry is a powerful lobby that lines the campaigns of many politicians.  And while that is certainly true in part, it is also important to consider that despite their shortcomings, Payday loans may fill a useful niche for a very small portion of the population.

Making the Best of Payday Loans

Those individuals who cannot attain credit cards, have no friends or family to loan then money, and cannot procure an advance from their employer, often have nowhere to turn for a bit of extra cash to fill a very short term need.  Under these circumstances, and only under these circumstances, can one find an acceptable use for Payday loans.  In these types of situations, it is important for borrowers to carefully examine the conditions of the loan.  For while it is essential that borrowers avoid the “rollover-trap” the reality is that some will not.  And if you fall into that unfortunate few, it is important that you know the contract you have signed.

Of particular note in the contract is:

	-What recourse the lender will take if you fail to pay on time

	-What the APR of the loan you are taking is

	-What the rollover policy of the lending agency is and, 

	-What their history with pursuing criminal actions against those that default is

While knowing these things and comparing them with their competitors will not convert the decision to take a Payday loan into a pleasant one, it will help limit the damage of those loans and hopefully eliminate the possibility of you slipping into the rollover-trap that captures so many Payday Loan users.



