Pay Day Loans: Life Saver or Death Trap?

Pay day loans may sound like the perfect solution when you have an emergency or just need some extra cash. It sounds easy: no credit check, no assets to pledge, and no waiting. But is a pay day loan a life saver or a death trap?

Pay day loans got their name because people would run out of cash between paychecks. A loan was made until pay day when it would be paid back. Now pay day loans, also called cash advance loans, means a loan that is granted immediately, doesn’t rely on a credit score, and isn’t secured on assets. The loans can be granted in as little as 30 minutes. The catch is that the fees are high. The interest rate is usually at the highest level permitted by law and if that was the only fee there wouldn’t be any problems. The application fee runs from 5% to 10% of the loan amount and is due when the loan is paid back in 30 to 60 days. That doesn’t sound so bad, does it?

Well a $1500 loan at a 10% application fee would cost $150 for a period of 60 days. That’s an annual rate of 60%, in addition to the actual interest rate, say 24%.

Here’s how the process works. The customer writes a check on their personal account, or gives their debit card information, for the amount of the loan, interest, and the application fee that is post dated for when the loan is due. In this case the check would be for $1690 ($1500 for the principal, $150 application fee, and $40 for two months interest). The lender cashes the check on the date it’s written for. So far everything is fine. But if the customer doesn’t have the money in their account their only option is to roll the loan forward for another 60 days and pay another application fee and interest rate. This time the application fee is $169 because the loan amount is $1690 not the original $1500.

Many people who have taken out a pay day loan find themselves trapped as the amount grows larger and larger. Nearly 60% of those obtaining a pay day loan do not pay it back the first time it’s due. It’s conceivable that the final loan amount owed is two to three times the original loan amount.

There are different scenarios. Some pay day loan lenders require the application fee to be paid at the time the loan is made by subtracting the fee from the loan proceeds. In other words the loan amount owed is $1500 but the amount paid to the customer is $1350.

The length of the loan period dramatically affects the cost of the loan. A pay day loan that is due in two weeks has an application fee the same as one that is due in two months. So if you roll over the loan every two weeks you’re paying four application fees compared to the longer term loan period of two months with one application fee.

If you’re thinking that you will default on the check, don’t. Writing a check that you know you’re not going to pay is a crime in most states.

A pay day loan is a very high cost loan, even though it’s convenient, fast, and doesn’t require good credit.