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Are Payday Loans Useful for Emergency Expenses?

Even the best-planned budgets can unravel in the face of the unexpected. When you’re in a financial pinch, it can feel as if your options are limited.

In today’s ever-changing economic environment, an emergency savings fund may not be enough to cover everything that life throws at you. As a result, it may be necessary to take out a loan. Then, it becomes a matter of finding where to borrow the money.

One option is the payday loan. Let’s talk about what this lending vehicle is, its advantages and risks, and finding alternatives.

What Is a Payday Loan?

Investopedia defines a payday loan as a short-term, high-interest loan that lenders make based on a borrower’s income. The typical loan amount is a portion of the borrower’s next paycheck.

Payday loans are regulated differently across the United States. In Florida and other states, these products are also known as “deferred presentment.”

How a payday loan works will vary from state to state. In general, they work like this:

  • A borrower presents proof of identification and income to apply for a payday loan
  • The lender provides a lump sum that the borrower will pay back
  • The borrower is expected to pay back the loan within a short timeframe, typically 2-4 weeks

Two common ways to pay back a payday loan include:

  • Direct deduction from a bank account: Borrowers provide their financial information as part of the application process. This allows the lender to contact the financial institution and take the borrower's payment directly from their account when the due date arrives.

     

  • Writing a check: The borrower may opt to write a check, which must be posted by the agreed-upon due date to avoid any penalties or additional fees.

Why a Payday Loan May Seem Like an Appealing Option

Payday loans are appealing for several reasons. They are advertised as a way to get cash quickly to cover a sudden expense. To a borrower who needs quick cash, this is enough to want to sign up for one.

Also, payday loans don’t require credit checks, so a borrower with bad credit or no credit history may consider this lending product a viable alternative.

Finally, payday loans are unsecured loans. This means borrowers don’t have to provide collateral or put up something valuable to borrow money. Signing up for this loan may be better than doing business with a pawn shop or hosting a last-minute garage sale.

Why a Payday Loan Might Not Be a Good Idea

Payday loans may offer quick relief for a financial emergency. However, they’re far from ideal. Some characteristics of this loan may ultimately hurt a borrower.

  • Payday loans have disproportionately high fees. Although payday loans may not charge interest in the conventional sense, their fees more than compensate for that absence. According to the Consumer Financial Protection Bureau, a typical two-week payday loan costing $15 per $100 borrowed can equate to an annual percentage rate of almost 400 percent.

     

  • Skipping a payment can hurt your credit score. Payday loans are meant to be paid off in one installment. The loan servicer can report delinquent borrowers to credit bureaus, and as a result, the borrower may be denied in the future when applying for a credit card, car loan, or mortgage.

From a practical perspective, a payday loan requires a borrower to forego their next paycheck and more in exchange for quick cash. And if the borrower can’t pay the loan on time and needs an extension, they may pay even more in fees.

Consequently, this can kick off a debt spiral that leaves borrowers in an even larger pit than where they started.

You Have Alternatives to Payday Loans

Always remember that you have alternatives to taking out a payday loan. Working with established institutions will give you the necessary information to make sensible financial decisions.

Alternatives include:

  • Getting a personal loan from a bank or credit union: Many financial institutions offer personal loans or lines of credit. You can discuss the loan amount and repayment terms with the lender to ensure the costs remain manageable.

     

  • Using an Installment Payment service: Does your emergency involve replacing a home appliance or electronics? Many retailers have partnered with installment payment servicers (think Afterpay, PayPal, and Klarna). These services allow you to pay for items in equal installments over time without paying interest. They are also known as BNPL (Buy Now, Pay Later) services. Visit your preferred retailers for more information.

If you need to take out a payday loan, you must know your rights as a borrower. Payday lenders are regulated in the state of Florida. Review your protections by visiting the Consumer Resources section of Florida’s Office of Financial Regulation website.

First Florida is committed to helping you make informed borrowing decisions. Explore our website for resources on financial wellness. You can also learn more about our personal loan and line of credit options that can help with unexpected expenses.

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