The Pitfalls of the Payday Loan Cycle

Payday loans seem harmless enough. They are short-term, personal loans designed to help you with an unexpected expense such as a car repair or medical bill. However, if you’re not able to repay the loan and interest on your next payday as promised, it’s easy to get stuck in a cycle of paying only interest every pay day. The trick with payday loans is that unless you can repay the entire loan including the interest due on the date agreed, the only choice you have is to roll over the loan, paying only the interest. The payday loan company will not allow you to pay anything toward the principal, the base amount of your loan. They will only accept an interest payment that lets you roll over the loan with the hope that you can pay off the entire loan plus interest on your next pay day. As you can imagine, paying the loan company interest every pay day, but never reducing the initial amount you borrowed only continues to take money out of your pocket and gets you no closer to paying off the full loan. This is what is referred to as the payday loan cycle and it happens to most people who take out payday loans.

Payday Loans on the Rise

The reluctance of banks and credit unions to lend to people with less than perfect credit has given rise to payday loan stores on virtually every corner adding to this vicious cycle. And these loans aren’t cheap; another reason for the explosion of storefront lenders. When you stop and look at the numbers, you’ll see that payday loan stores are making a tidy profit. The average finance charge ranges from 15 to 30 percent of the principal, the base amount you borrowed. Of course, since it’s 15 to 30 percent over a few weeks, that is comparable to an 800% annual percentage rate. A steep price to pay for a few hundred dollars to help you out of a jam.

Bank Fees Usually Follow Payday Loans

The worst part comes when the people who borrow from payday lenders can’t repay their loans as scheduled. This leads to individuals with a negative checking account already suffering from financial hardships being hit with bank non-sufficient funds (NSF) and other fees for bounced checks they wrote to the lender, putting them deeper in the hole than when they began. Even if an individual manages to pay off their payday loan on schedule, they often find that they can’t pay their expenses and end up taking out a new loan, and the cycle of debt continues.

Getting Out of the Payday Loan Cycle

There are ways to get the money you need without taking out a payday loan. One alternative is to ask for a cash advance on your next paycheck from your employer. Many companies will make an interest-free loan available to their employees in case of emergencies. You can’t go to this well more than a couple of times and you need to truly be in crisis, but since most companies prefer employees who are able to focus on their jobs instead of on their personal problems, you’ve got a good shot at getting the money you need.
Bringing items of value to a pawn shop to collateralize a loan is another way to generate cash without getting a payday loan. Pawn shops lend cash for jewelry, electronics, tools, and more. However, pawn shops can be as slippery a slope as payday loans. The danger with pawn shops is if you’re unable to pay the interest or redeem the items on the specified date, you may end up losing your valuables. The rates of pawn shops are governed independently by each state, but they are not cheap. The upside of pawning items is that once you’ve redeemed your valuable or lost them to the pawn shop, the contract is over and there are no additional fees unlike with payday loans.

Better Than a Payday Loan

Instead of a payday loan, perhaps a better option is to take out a signature installment loan from an Internet-based lender. With this kind of short-term loan, there’s no collateral, you only pay interest while you have the loan out, and there’s never a penalty for early repayment. Most people pay back their signature loans sooner than the full term of the loan saving them a ton on interest.
Emergencies happen to everyone. However, the best thing you can do is to be prepared by having an emergency fund in place. Barring that, try to opt for one of the alternatives instead of a payday loan.