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When is a Payday Loan
a Good Option?
by Credit.com
Emergency payday loans are controversial. With annual percentage rates as high
as 5,000%, payday loans can seem like a terrible deal. In this article, our credit
experts compare the costs of some alternatives and explain when using a payday loan
may actually a good idea.
Before we get started, you may want to read up about how payday loans really work.
Credit.com's article "The Truth
about Payday Loans" explains all the details.
A Case Study
Let's look at a specific example to see how a payday loan could be helpful. Consider
the situation of a man we'll call Joe. Joe had to repair his car this month and
doesn't have enough money left in his bank account to pay his bills. His two credit
cards, car loan, and a utility bill add up to $300. Here is a breakdown of what
he owes:
- Credit Card: $35
- Credit Card: $35
- Auto Loan: $200
- Utility Bill: $30
Joe doesn't get paid for another six days and the bills are due now. He currently
has only $20 in the bank and will be paid $800 after taxes next week. Joe usually
pays his bills on time and has pretty good credit. What are his options?
| Options |
Pros |
Cons |
Charges |
Total Costs |
| Obtain an emergency payday loan for $300. |
The money is deposited into his account overnight. No credit check required. |
If Joe doesn't pay back the payday
loan within the 14-30 day term, his costs can increase dramatically. |
A payday loan for $300 dollars costs
$60 to $90 total, depending on financial standing.
|
$60-$90 |
| Pay the bills by check and simply
hope for the best. |
It's possible that some of the payments
may not be processed until after Joe gets his next paycheck. |
Most likely, the checks will bounce
and Joe will be charged expensive fees. |
Both banks and retailers charge about
$25 per bounced check. For five bounced checks, Joe will owe at least an extra
$250. Plus, these bounced checks could appear on his ChexSystems record for
five years. |
$250 |
| Pay the bills by check and count
on overdraft protection from the bank. |
Joe will be able to pay all his bills
on time, as long as his overdraft protection covers his payments. |
His bank will charge expensive overdraft
fees each time his payment checks bounce. |
At $25 per overdraft charge, paying
five bills could potentially add up to $125 in overdraft charges. |
$125 |
| Pay his car loan and utility bills
using his credit card and skip his credit card payments. |
Joe will avoid making late payments
on his loan and utility bills. |
He will still make late payments
on his credit cards and it will be expensive to get a cash advance with his
credit card. The late credit card payments will damage his credit. |
$70 in late fees for the two credit
cards. The interest rate for a cash advance will be about 22%-30%. If he pays
the debt off in two months it will cost him about $5 in interest. Joe's rates
may go up because of his late payments, costing him more. |
$75.00 |
| Skip paying his bills until after
he gets his paycheck. |
His loans will not be foreclosed
or his utility accounts closed due to just one month of late payments. |
He will have to pay late fees for
each account. The credit card and loan late payments will damage his credit
scores. |
$70 in late fees for the two credit
cards plus a 10% late fee on the utility bill. Also, Joe's interest rates may
go up because of his late payments, costing him even more.
|
$73.00 |
| Borrow money from a friend/relative
or request an advance on his paycheck from his employer. |
Joe will get the $300 he needs without
any fees or interest rates. |
It can be embarrassing to ask to
borrow money. Borrowing could strain Joe's relationships if he can't pay it
back quickly. |
No costs. Only Joe's pride is damaged.
|
$0 |
| Ask his creditors, lenders, and utility
companies for help. |
Many financial companies offer assistance
to customers struggling with paying their bills. Since Joe is usually a good
customer, he may be able to move his due date or have his late fees waived.
|
Not all companies are willing to
help. Joe will have to spend a lot of time on the phone speaking to each company.
|
No monetary costs if Joe manages
to work out agreements with all five companies. Joe's time is the only cost.
|
$0 |
Joe's Choices
In Joe's situation, an emergency payday loan is actually one of the more affordable
options. As long as Joe repays the loan as soon as he gets his next paycheck, this
may be his best choice. Skipping his bills, bouncing checks, using overdraft protection,
or paying with his credit cards could all end up being more expensive than using
a payday loan. Joe would do better by borrowing the money from a friend or using
his savings, but these may not always be realistic options.
Conclusion
Payday loans can be very expensive. But when used responsibly, a payday loan may
be more affordable than the potential alternatives. If you are considering obtaining
a payday loan, be absolutely sure that you can pay the amount you borrowed back
within the 14-30 day loan term.
Payday loans are also known as "cash advance" loans because they are
designed to be repaid as soon as you receive your next paycheck. When you are unable
to repay the loan within the specified period, the loan is not being used correctly
and quickly becomes very costly. You can read more about payday loans and the state
laws that govern this industry online.
Still have questions about payday loans? Send us an email at cs@credit.com.
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