Payday loans have grown in popularity over the past four years, despite the fact that these loans often come with large interest rates. As traditional banks have tightened their lending standards, many people have been forced to use payday lenders instead of a credit card or home equity line of credit.
Payday loans typically start when a customer or borrower writes a post-dated check to the payday lender. The lender then issues cash, minus a service fee, for the amount on the check. When the date written on the check arrives, the payday lender cashes the check.
If there are not enough funds available for the check to be cashed, however, the borrower must take out another payday loan. This new loan costs a new service fee. This cycle can continue forever until the borrower manages to come up with the funds to pay back the original loan.
The cost of these service fees varies, but studies have shown that if a customer has to pay a service fee every two weeks, the amount of money that he or she will pay to service the loan will be equivalent to that person paying around 450% interest on the loan. While new banking regulations have brought this amount down to 30% in some areas, this is still some of the highest interest debt that a person can take on.
For this reason, it is important for people who are considering taking out a payday loan to make sure that they can pay the loan back on time. In general, a payday loan company is not allowed to charge more than 30% of the total amount loan in fees. This means that a loan of $500 could not have a service charge of more than $150. In many states, the fees are even less. By paying off the loan on time, the amount paid in fees will be high, but it will not cost the thousands of dollars that these loans can cost a consumer.
When possible, avoid payday loans, but if you absolutely have to have a loan, make it a priority to get the payday loan paid off quickly.