A few years ago, a couple I know got into trouble with some payday loans.  Hard on their luck and desperately in need of groceries, they spent a couple of weeks taking out payday loans from one of those conveniently located check-cashing places.  Before too long, they were drowning due to the payday loans.  While they wouldn’t have had food in their home otherwise, here’s a list of things that would have helped them (and can help you) before they were in over their heads in a high-interest debt situation:

1. A Payday Loan is a type of short-term loan

   For the most part, all you will need when applying for one is a checking account, a steady source of income, and a valid ID.  It does not require a credit check.  Most loans are for a period of between 7 and 62 days.

2. Interest Rates are higher.

   Because payday loans do not require a credit check (in most cases) before the checks are cashed, the companies compensate for the problem by hiking up the interest rate.   Some of these rates may be up to 1300% per annum – so that loan you take out for $300 could wind up costing you $3900.  Ouch!

3. Repeat Customers keep payday loan companies in business.

   That’s right, like the couple I know, most people who apply for a payday loan find themselves needing to apply for another – and another, thus continuously driving themselves further into debt – and at that high rate of interest.
   

4. Those most likely to request payday loans tend to be low-income.

   This means they are less likely to have an emergency fund set aside.  When unexpected expenses hit, they often fall prey to the payday loan cycle.  The best way to avoid the payday loan cycle is to avoid taking out a payday loan in the first place.  Set aside a portion of every paycheck for an emergency fund.

5. In May 2009, new legislation was proposed in Australia governing payday loans.

   This law will advocate licensing procedures that requires lenders to also provide information on payday loans to borrowers at the transaction’s initiation.  It will also require credit checking – intended to help keep consumers out of trouble by keeping them from taking on more debt than they can pay back.

6. In the United States, payday loans have been banned in 11 states.

   The New York Times profiled a man who spends $1500 a month just paying the interest on payday loans.  The cycle is vicious, and government officials over the world are beginning to catch on to how predatory these lenders can be.

7. Because the loans are easy to get, you can wind up in trouble faster than you expected.

   Most people don’t expect payday loans to become a permanent solution, but because of the astronomical fees associated with the loans, wind up becoming dependent upon the system just to barely keep their noses out of the deepening debt waters.

8. Payday Loans should be a last resort.

   This is why establishing an emergency fund is so important.  If you have no assets that can be liquidated should a crisis come along that requires money you don’t have, you have no one who can lend money to you, and all other options are also exhausted, then get a payday loan.  Payday loans should never be used because you paid your bills and don’t have anything left over for buying that new video game system.  For ten alternatives to payday loans, you might want to read “10 Options to Consider before Getting a Payday Loan” by Trent at The Simple Dollar.

What happened to the couple I knew?  They eventually crawled their way out of the hole with help from family and friends – and a part time job.  For a while, however, it did put a strain on their relationship due to having constant financial stress hanging over their heads.  And both of them wished they had been more informed about the perils of payday loans before signing.

Photo by mag3737