Are Payday Loans Dangerous?

By Phillip Edmunds

Payday loans stir up quite a controversy in some circles. To hear some people tell the tale, payday lenders are little more than mafia-backed loan sharks who are out to take advantage of you in your most desperate time of need.

Still, there are those that claim payday loans are a valuable and necessary service. Traditional financial institutions typically aren’t willing to make small, short-term loans to people, especially when their credit is a little bit shaky. So, people turn to payday loans to fix their short-term financial needs.
Are Payday Loans Dangerous?
How they work

A payday loan is a short-term loan. The lender provides you with cash today in exchange for a check dated into the future – typically two weeks. You provide the lender with some form of income verification. The amount that you get back in cash is less than the amount of the check you write, because the check includes the payday loan fees.

So, for example, you might take out a payday loan of $200. You write the check for $235, and it’s cashed in two weeks after you’ve been paid.

What’s wrong with this?

Unfortunately, the short term fix may have long term financial consequences. The terms on a payday loan are significantly worse that the terms on other types of credit. The annual percentage rate (APR) of a payday loan can reach up to 400 percent or more in some places, and is typically at least 250 percent. This puts payday loan interest rates somewhere between 10 and 40 times the rate of a more traditional type of credit.

Even that in itself isn’t always bad for the borrower. The problem comes when the borrower doesn’t have enough money in her account to cover the check that she wrote.

What the borrower then has to do is go back to the payday lender, who is usually willing to give them another loan – complete with another fee. As you can imagine, at a fee of $35 every two weeks the interest on that $200 can add up extremely fast. In fact, you’re looking at an interest rate over 450 percent.

The solution

The solution to payday loans isn’t to shut the businesses down, however. It’s to find other forms of short-term and low-value credit. Whether it’s micro loans, peer-to-peer lending or even borrowing money from your uncle Joe, there are a number of ways to avoid the payday loan jam.