Payday loans and other short-term loan products are well known for having a high annual percentage rate. APR, a figure that tells borrowers how much the loan will cost over the course of a typical year, is a quick way to compare loans and lenders. APR typically falls in the range of 15% - 20% on most credit cards. For payday loans, that average APR rises to 339%.
Since the loan is designed to be paid off in a span of a week or two, that yearly APR often has little meaning. However, when used incorrectly, a borrower's debt can increase rather quickly due to the unique structure of these types of loans. That's why all payday borrowers should keep one important fact in mind--they are borrowing time, not money.
Understanding why this is the case--and a few other related points--is critical to avoiding additional costs and increased debt. You'll be much more likely to use the loan as intended, and you won't make your financial situation worse as a result.
Point #1--These Loans Don't Solve Problems--They Delay Them
Payday loans are meant to be used when unexpected issues that require cash come into your life. For example, you might not have a savings account for repairs on your car. If your car breaks down, you'll need to find the money required to get it fixed. Otherwise, your job and your standard of living are compromised.
These loans will get you to your next paycheck--giving you a week or two to figure out how to pay the balance. You'll also get to attack that problem with a working car. However, the payday loan simply costs too much to be used as a way to make payments over time. You'll have to figure out some other way to deal with this new debt. The cost of rolling over payday loans for long periods of time is just too large.
Point #2--Payoff Plans Will Require Significant Changes
The emergency that required you to get a payday loan probably felt threatening and immediate. That sense of urgency shouldn't go away when you qualify for a payday loan. If you have adequate financial resources to handle the emergency without a major change, you'd probably be fine without taking out a payday loan.
That means you'll need to create a plan once you've acquired your payday loan. This plan should include:
- A means for long-term financing (credit card, personal loan, family assistance) and repayment.
- Changes to your budget and living costs to create a surplus
- Consideration of selling personal assets to repay the loan
A payday loan gives you the time required to procure traditional financing, contact your friends and relatives, and make the required changes to address the issue. Use this time to make your plan--don't let the payday loan become the plan by itself.
Point #3--Every Rollover Makes These Changes More Difficult
The reason for a payday loan's high APR is the way that finance charges are calculated. On average, it costs between $15 and $30 dollars for every $100 that you borrow. Unlike a credit card, which is an ongoing balance, your payday loan is due in two weeks. At that time, you'll need to pay finance charges again to maintain the debt.
There might be reasons in your life why it could be easier to pay the loan in full in a month or two--income tax rebates come immediately to mind. That said, you will add a significant amount of debt to your bill every time you roll the loan over. That's why it's important to use this short time wisely. Make the difficult changes immediately or you'll need to make even larger sacrifices down the road.
When used appropriately, payday loans are a valuable financial tool that can help people out of difficult situations. Just remember, you're not eliminating your issues by taking out the loan--you're simply delaying them. Use the precious time that this creates wisely, and you'll keep your costs and frustrations to a minimum.