Everything you need to know about payday loans

Angela Lang/CNET

For the millions of Americans who live paycheck to paycheck, lack of money is a constant and looming concern. According to Federal Reserve Bank of St. Louis. And while these loans can help them survive until they get their next paycheck, they also exact a heavy price. Yet with millions of Americans unemployed or faced with reduced hours due to the COVID-19 pandemic, many will continue to rely on this dangerous financial tool.

If you don’t have a strong credit history, it can be difficult to get a traditional loan or a credit card. But there are plenty of lenders out there that will let you borrow without a credit check, with few questions asked. The conditions will however be severe and they will certainly end up costing you much more than what you borrowed. With a deserved reputation for “predatory lending,” payday lenders have dragged many borrowers into a spiral of debt and regret.

If you’re short on cash, you’re not alone. But before you take out a payday loan, let’s take a look at what they are, why you should avoid them, and who you can borrow money from instead.

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What is a personal loan?

A payday loan is an unsecured short-term loan that usually comes with a high interest rate. Most payday loans are for small amounts, usually $500 or less.

With a traditional loan, you receive a lump sum and then start making repayments over a set period – from a few months to a few years – with a “reasonable” interest rate added. With a payday loan, the full amount is due at once, including interest and fees. In most cases, you must write a post-dated check for the full amount owed – the loan, plus interest and fees – or authorize your lender to debit the money from your bank account on that date.

Payday loan interest rates are much higher than traditional loans. A standard APR for a personal loan ranges from 6% to 36% – but lenders offering payday loans can charge annual rates of 100% or more, and some have proven to be over 1000% according to a 2013 ProPublica survey. That said, some states have limits on interest and fees – and in some states, payday loans are completely prohibited.

It should also be noted that payday lenders tend to target people who live in areas with high poverty rates and low income levels, as well as minorities and economically disadvantaged groups, who have traditionally had harder to qualify for conventional loans, according to a study by the St. Louis Fed.

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Why You Should Avoid Payday Loans

There are twice as many payday lenders than McDonald’s restaurants in the United States – and borrowing money from one of them is about as easy as ordering a burger and fries. Getting approved is relatively easy: many payday lenders won’t even check your credittherefore a tarnished credit history will not be a factor.

This is an advantage for people with poor or limited credit history. But high interest rates and strict repayment terms force many people to fall into the trap of payday loans where they are forced to take out new loans just to pay off existing ones.

If you don’t have enough cash to repay your loan when it’s due, the lender can automatically trigger a direct debit from your bank account. And if you don’t have enough money in your bank account to cover the charges, you could face an additional “insufficient funds” penalty. You may also be subject to penalties from the lender if they do not receive your money on time.

If your state allows payday lenders, you might see them in some parts of your city and not others. For example, there might be more where poverty rates are high and income levels are low. These types of lenders tend to target minority groups as well as those with very low credit scores who don’t otherwise qualify for traditional loans.

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Alternatives to payday loans

If you urgently need money to cover basic expenses, buy food, or pay off high-interest debt, there are other options to consider. Here are a few:

Online lenders

There are many personal loans available online at more reasonable interest rates. Even if you have less than stellar credit, some lenders may look beyond your credit score when assessing your eligibility.

  • OneMain Financial has no minimum credit score requirement and you can borrow as little as $1,500, depending on where you live. APRs range from 18% to 35.99% and terms are two to five years. They also have a pre-qualification option to see if you qualify without applying first.
  • Loans before start around $2,000 and your credit score must be at least 580 to qualify. APRs range from 9.95% to 35.99% and repayment terms range from two to five years.
  • Reached takes your educational background and experience into consideration when assessing your eligibility. You can borrow as little as $1,000 and get your money back within a day of approval.

These lenders tend to have higher than normal interest rates compared to other personal lenders. However, they are all much cheaper than payday lenders.

credit unions

If you have an account with a local credit union, it may be easier for you to qualify for a personal loan. Most credit union interest rates are capped at around 18%, even for those with low credit ratings.

Many credit unions also offer payday loan alternatives — offering small dollar loans and short repayment terms ranging from one to six months. Many credit unions require you to join before borrowing, but are willing to work with you if you don’t have good credit.

Recruit a co-signer

If you can’t get a loan from an online lender or credit union, you can ask a friend or family member to co-sign a loan. The co-signer must have decent credit; it is their score and credit history that will help you overcome the eligibility problem. Keep in mind that if you fall behind in your payments, not only your credit report to suffer; so will your co-signer.

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Mara R. Wilmoth