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The Hidden Cost of Payday Loans
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Financial Expert
Posted February 7, 2017
What is a payday loan?
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For a college student or recent graduate, money can be tight. Sometimes, making ends meet can be difficult. Sadly, there are companies that will take advantage of people struggling with financial hardship. This is how “payday lenders” make money. A “payday loan” is a small, short-term loan that is typically used by people living paycheck to paycheck. They are also sometimes called “payday advance loans” or “cash advance loans.” People often open these loans because they think it is the only option to pay their bills when they do not have enough income or for some other reason are short on cash between paydays. However, this type of loan has an extremely high interest rate – also known as an annual percentage rate (APR). According to the Consumer Financial Protection Bureau, a typical two-week payday loan has an interest rate of 400% APR. That means if the borrower takes out $100 to help cover bills, it will cost about $110 in interest, in addition to the $100 owed. Therefore, they would pay more than double the amount originally borrowed. While 400% APR is average, there are payday loans with over 1,000% APR. By comparison, the majority of credit cards have rates from 12% to 30% APR.
The cycle of debt
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Due to high interest rates, payday loans often start a cycle of increasing debt. Because the borrower is usually not making enough money to cover expenses, a payday loan is needed to supplement every paycheck. Even if a borrower pays off a payday loan quickly, the interest on the loan can leave them short of cash, leading to another payday loan being taken out. Then, they owe a large amount for the payday loans, in addition to regular expenses. This causes the borrower to take out even more payday loans. As the amount borrowed increases, so do the monthly payments. In some cases, the borrower is no longer able to pay their bills or the payday loans. Late payments can damage the borrower’s credit standing, making it difficult to get other kinds of loans, housing or even employment.
Breaking the cycle
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The first step in breaking this cycle of debt is recognizing there is a problem. It can be challenging to step back from a financial problem and look at the bigger picture. Once the issue is identified, the borrower can begin resolving it. The borrower needs to reach out to their financial institution. If the borrower is behind on payments, their institution may be able to help by offering a payment plan. The financial institution may also have advice for budgeting, or offer a debt consolidation loan to give the borrower a lower overall monthly payment. If additional assistance is needed, the borrower can go to a credit counseling company. Credit counselors are often able to help set up budgets, and in some cases are able to work with the lenders to lower monthly payments or reduce interest rates. As with all financial advisors, research the credit counseling company to ensure it is reputable. Typically, nonprofit credit counseling companies are less expensive and more likely to have the borrower’s best interest at heart. Visit the National Foundation for Credit Counseling’s website at to find more information about credit counseling.
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