Why you should avoid ‘payday’ loans - and how to do so

Think twice before taking out a payday loan.
Think twice before taking out a payday loan.

If you're facing an emergency or are simply short of money, a payday loan – also called a cash advance, check advance or deferred-deposit loan – may seem like the answer. But while these loans can seem helpful on the surface, they’re can be quite ugly on the inside.

A typical payday loan has three characteristics: It has to be repaid very soon, usually from your next paycheck; you have to give the lender access to your checking account or write a check that the lender can deposit as soon as the loan is due; and it's usually for a relatively small amount of money, such as $500.

Payday loans involve extremely high rates. For example, a fee of $45 for a two-week loan of $300 works out to an annualized percentage rate of almost 400 percent. That's much, much higher than the rate for almost any other type of loan, and the fees can add up fast when a short-term loan is rolled over into a new loan at the end of the term. Borrow that same $300 for just six weeks and you'll pay $90 in fees.

Here are some alternatives to a payday loan:

Credit card: While credit-card debt is not ideal, it's generally cheaper than a payday loan, especially if you pay off the credit card during the grace period or as soon as you can. Interest rates on credit cards can be high, so make sure you understand how much it will cost you in total if paying it over time.

Emergency credit: A counselor at a consumer credit counseling agency can tell you about nonprofit organizations or community groups in your area that offer short-term loans or grants to people in financial distress. A counselor can also help you set up a budget and learn money-management skills.

Creditors: If you need money because you can’t pay your mechanic, plumber, dentist, attorney or someone else who provided or will provide a product or service, ask to set up a payment plan that will let you pay them what you owe in smaller amounts over time.

Family and friends: Though it may seem embarrassing to ask a loved one or friend for a loan, tapping your support network can be much more affordable than a payday loan and much less likely to trap you in a downward debt spiral.

Personal loan: An unsecured personal loan from a nonbank lender is usually less costly than a payday loan. They are typically for larger amounts than payday loans and can be repaid over a longer period. Be sure you understand the terms and, again, try to pay off the loan as soon as possible.

Pawn shops: While it might be painful to turn your treasured belongings into cash, selling your jewelry, sports equipment, musical instruments or other items can be preferable to a payday loan.

If you're currently trapped in a payday loan, talk to a credit counselor or legal aid attorney who can help you negotiate more reasonable terms or consider other options to resolve your financial difficulties.

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