Unexpected circumstances combined with a bad credit rating and little to no savings can make payday loans look very attractive to anyone. You may feel like a quick “no-questions-asked” loan is the only solution to get you out of financial trouble. And it will… in the beginning at least.
However, it’s quite easy to get pulled into the vicious cycle it creates and more often than not, you end up in more debt than what you started with.
What is a Payday Loan?
Designed to “benefit” individuals with poor credit rating and no savings, this type of short-term loan is granted quickly and with very few questions asked. Usually, the lender will only require a verification of your income and a bank checking account. They don’t care about your credit history or score as long as they have those two important pieces of information. In under an hour, the borrowed amount will be in the verified bank account provided.
Unlike traditional short-term loans, a payday loan has a term of only 2-4 weeks — just in time for your next payday! Before you are granted the loan, the lender will have you write a post-dated check to pay for the money that you owe plus the interest. This money will be withdrawn from the same bank account they verified to be yours.
The loanable amount is usually ranging between $100 to $2,000. It’s possible to borrow a larger sum, but lenders who offer this type of loan rarely go over the $2,000 because they know that the larger the loan, the less likely they will get paid back given the loan fees that they impose.
What is the Interest Rate for a Payday Loan?
Payday loan fees are exorbitant to say the least. As an example, a $500 loan must be paid back with the interest of $75 after only two weeks. That’s a 300% interest when computed annually! For comparison, a more traditional short-term loan will be repaid the same amount for a 12-year term (a fair deal for someone with bad credit).
Here’s more on how car loan interest rates work.
The worst part is, there are payday lenders that charge as much as 500% in interest. And yes, it is legal and is also known by another name — Small Amount Credit Contracts or SACC. There have already been reviews and recommendations to curtail the schemes of payday lenders but much of the practice still continues.
So why are there still people who take out this type of loan?
Most individuals with bad credit or without savings feel like they have no choice but to buy into the unfavourable terms of a payday loan just to survive a financial emergency. A $500 loan (with $75 interest) that can be granted even without a good credit score will feel like a quick way out. However, this isn’t always the case.
The Pitfalls of a Payday Loan
The problem with a payday loan is that it almost always leads to another. A lot of people in dire financial straits are caught in the cycle of taking out a new payday loan to pay for their previous payday loan. In the course of a year, they could be paying hundreds just in fees for what’s technically a $500 loan amount. The amount they borrowed to solve one problem morphs into a monthly problem that they can’t seem to catch up on.
Fortunately, there are other alternatives.
Payday Loan Alternatives
If you want to avoid the trap of a payday loan but you have a poor credit score and barely any savings, the best option for you is a personal loan.
Contrary to popular belief, not all lenders will turn you away. There are reputable lenders who let individuals with poor credit scores take out a loan. Although a personal loan will still accrue interest over time, it is nowhere near what payday lenders charge.
To completely avoid ending up in a situation where a payday loan is your only choice, you must act now either to boost your savings or to improve your credit score.
Saving more money for emergency situations will require you to make certain sacrifices: working more hours, cutting on spending, selling possessions you don’t need, or even simplifying your lifestyle.
On the other hand, to improve your credit standing, you can choose to take a credit builder loan. This special type of loan will allow you to improve your credit scores by lending $500 to your name, payable in 12 months at 10% p.a. You won’t be able to access the loaned amount which is kept in a bank account under your name. The monthly repayments will be taken out of this account. In order for you to make the monthly payments, all you need to do is deposit enough money to cover the loan and its interest for the year which is only around $50.
Get a better Car Loan with Aussie
Want to chat about your loan option for a new car while avoiding to take out a payday loan? We can provide information about a range of loan products, or discuss the possibility of refinancing an existing loan.