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Why Are Payday Loans Bad?

Janet Berry-Johnson • October 16, 2024

Payday loans might seem like a quick fix when you’re in a financial pinch – an easy way to get cash fast to cover an unexpected bill or expense.

So why are payday loans bad? Because they come with hidden risks and high fees that can trap you in a cycle of debt, costing you far more than you borrowed.

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What are payday loans?

Payday loans are short-term, high-interest loans that give you fast access to cash with the expectation you’ll repay it in full on your next payday.

You just need proof of income, a bank account or prepaid card account, and valid identification, and you can walk out with the money almost immediately.¹

Sounds convenient, right? It is – but that convenience comes at a steep price.

Why are payday loans bad?

Like most things in life, payday loans have pros and cons – but the balance here tilts heavily toward the “con” side.

Payday loans are expensive

One of the dangers is payday loan interest rates. The average payday loan has an annual percentage rate (APR) of 400%, compared to the average APR for a credit card of 22.8%.²

For example, say you need to borrow $300 for two weeks. With a payday loan, you’ll end up paying $46.03 in finance charges. If you borrowed the same amount on a credit card with a 22.8% interest rate, you’d end up paying just $2.62 in interest.

But the real payday loan cost comes if you can’t repay it on time.

Payday loans can trap you in a cycle of debt

Because of their high cost and short repayment terms, payday loan borrowers may have a tough time repaying these loans on time.

Many payday lenders allow borrowers to “roll over” the loan for an additional fee. This feature may seem helpful, but it can trap you in a cycle of debt, where you’re constantly paying fees without reducing the amount you owe.

For example, on a $300 loan, a borrower might pay $45 to roll over the loan every two weeks until they can pay off the balance. After four months, the borrower has paid $360 in fees but still owes the original $300.³

Payday loans don’t help build your credit

Another major downside is payday loans don’t help build credit because payday lenders don’t report on-time payments to the major credit bureaus.⁴ Instead, they can damage your credit and finances further.

Many payday lenders require a post-dated check or authorization to withdraw payments from your bank account. This might seem convenient, but if you don’t have the money in your account to cover the loan when it comes due, the bank may refuse to process the payment due to insufficient funds. When this happens, the payment lender and your financial institution charge a fee.⁵

Plus, the payday lender might send your debt to collections, causing a drop in your credit score.⁶

Safer alternatives to payday loans

Payday loans might seem like the only option when you’re short on cash, but there are safer and more affordable alternatives that won’t leave you trapped in debt.

  • Explore ways to earn additional income. Consider picking up a side gig or selling unused items to generate extra cash.
  • Consider taking out a pawn loan. If you have valuable items, a pawn loan might be better than a payday loan. With a pawn loan, you provide an item as collateral and can reclaim it after repaying the loan. Average interest rates are lower and these loans don’t damage your credit score.
  • Use a credit card for expenses. Credit cards generally have lower interest rates than payday loans, and you can make monthly payments over time. But credit cards also make it easy to overspend. Use them sparingly and avoid getting into debt that’s hard to repay.
  • Request a paycheck advance from your employer. Some employers offer paycheck advances, letting you get part of your paycheck early. This advance can help you avoid high-interest loans and gives you breathing room until your next payday.

Avoid problems with payday loans

Payday loans may seem like a quick and easy solution, but they create more problems than they solve.

Instead of falling into the payday loan trap, consider safer alternatives like earning extra income, exploring a pawn loan, using a credit card, or requesting a paycheck advance from your employer.

Need another quick and easy option for paying last-minute expenses? Find out how to apply for a personal loan.

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