Why You Should Avoid Payday Loans

Payday loans are high-interest, short-term loans that could push you into a devastating debt spiral and should be taken out only in emergency situations.

Aug 18, 2014 at 9:00AM

Payday loans have become a life-line for many American families strapped for cash. Payday loans are basically high-interest, high-risk, short-term loans largely made to sub-prime borrowers who don't have any other means of obtaining much needed funds.

According to research figures released by the Pew Charitable Trust in 2012, 12 million American adults depended on payday loans in 2010 to make ends meet while figures will most certainly have further risen until 2014.

In 2010, the average borrower took out eight loans per year with a loan size of $375 each and paid a whopping $520 on interest.

Payday loan companies providers clearly take advantage of cash-hungry, vulnerable consumers who need quick cash and are desperate enough to turn to these financing companies.


Source: Wikimedia Commons

While it is widely accepted in American society to take on consumer debt, payday loans should clearly be the absolutely last solution for people who need a short-term cash influx.

Payday loans are usually available on the spot, but they pose the very real danger of creating a dependency that could lead to a devastating debt spiral. So when you think about taking out a payday loan, you better understand very well what you are getting into.

The dangers of easy cash
The popularity of payday loans can largely be explained by how easy it is to obtain them. All you have to do is fill out on application, possibly on the Internet, agree to the lending terms and you get your cash fairly quickly.

Unfortunately, the availability of easy cash can seduce consumers and encourage them to adopt unhealthy spending habits.

Of course, there might be situations in which a short-term cash infusion will help you with an emergency such as paying for a car repair or a medical bill.

However, be aware that payday loans can push you in a debt spiral in which you are required to roll over one payday loan into the next one, with little hope of breaking the cycle.

Excessive interest rates
Make sure you understand, that payday loans are very short-term loans that need to be paid back in full plus sizable interest and fee components.

Annualized interest rates (also called annual percentage rates, or APRs) can be as much as a couple of hundred percent according to information from the Consumer Financial Protection Bureau and it is not unusual for borrowers to pay back a total of interest and fees that exceeds the amount borrowed.

If you take out a payday loan, be prepared to pay 100% or more of your requested loan size in interests and fees. There is a reason why payday loan companies can be compared to loan sharking operations.

Payday loans as a last resort
Given the excessive interest rates and fees being charged, payday loans clearly should be avoided at all costs. If you have any other chance of making up for your cash shortfall, by all means use it.

Do not use payday loans to finance purchases of consumption goods and resist the urge of taking advantage of easy credit. You will pay dearly.

The Foolish Bottom Line
Payday loans should be the absolutely last resort if you are strapped for cash. You are well advised to tap all other possible funding sources first and avoid payday loans like the plague.

The easy availability of fast credit also poses a significant risk of creating a short-term debt dependency in which consumers roll over their expensive payday loans into new loans on a consistent basis.

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Jun 12, 2015 at 5:01PM

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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