If you've ever found
yourself short of cash and waiting on your next paycheque, you may have been
tempted by one of the many companies offering payday loans. But are they worth
the risk?
A payday loan is a
loan taken out to cover expenses until your next payday, hence the name. The
companies offering them often tout their service as being quick and easy,
creating the image of an ideal way to get an advance on your wages, while
carefully drawing attention away from the potential pitfalls and risks involved
in such a transaction.
A payday loan allows
you to borrow a certain sum and then pay it back, with a specific fee added on,
when you get paid. The fee takes the form of interest, and as such the amount
increases the more money you borrow. Of course, the other major disadvantage is
that it adds up over time, too.
The payday loan
companies like to insist that this is not a problem - after all, you're only
borrowing the money for a week or so, until you get paid. But for a good number
of unfortunate borrowers, the situation unfolds in a different and far less
pleasant way.
Many people who end up
in the scenario where they desperately need money don't think too extensively
about the future, figuring they can cross that bridge when they come to it. But
when you set aside a chunk of your next paycheque to pay off your loan, you're
likely to be left short again at the end of the month - thus leading to what is
often referred to as the "payday loan trap" or the "payday loan
cycle".
The payday loan trap
arises when you end up dependent on these sorts of loans to be able to pay your
way. You might, for example, start off by borrowing £200 to keep you covered
until you get paid. When payday comes, you can expect to pay £50 on top of that
in interest - so you're £250 down before the month has even begun.
If your expenses are
reasonably consistent, that means that before long you will find yourself £250
short for the month - and chances are that going back to the payday loan
company will seem to be the only option. But the £250 loan you need this time
around increases to over £300 when you add interest - which leaves you with
even less cash the following month. It may sound ridiculous, but a great many
people's finances end up trapped in a constant downward spiral due to payday
loans.
Of course, this almost
inevitably leads to the eventual situation where the amount owed to your lender
exceeds your monthly wage, and you have to ask to defer your repayment. This is
when the high interest rate kicks in - with a typical rate in excess of 2000%
APR, a £200 loan would accumulate over £4000 in interest over the course of a
year. From this you can see how many people end up in dire financial straits
merely for needing to borrow a little spare cash.
You may be asking how
you can avoid this, or whether a payday loan is ever worth the risk. The payday
loan companies claim that responsible borrowers simply use their services in
emergencies - rather than using them to cover everyday expenses, they say,
people come to them when an unexpected problem comes up, such as unforeseen car
repairs or a high quarterly bill.
It's true that if
you're certain you will be able to pay it back, a payday loan can help out when
you need some extra money for a one-off expenditure. The problem is that you
still pay a hefty sum for the privilege, even if you do make the repayment on
time - and the trouble with unexpected expenses is that you never know when
another one is going to come up.
And, despite the
protests by payday loan companies, studies have indicated that their average
customer will make eleven such transactions a year - far from the one-off
emergency lending image that these firms would like to encourage.
So, if it's best to
avoid these companies, what are the alternatives, and what can you do if you've
racked up a vast debt with them already?
If you're short on
cash and looking for the best way to temporarily borrow some money, an
authorised overdraft from your bank may be a better route than payday loans.
Some banks do charge excessively so it is best to look into the specifics
beforehand, but this may be a less risky means of making ends meet.
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