Are payday loans good or bad?
Wrong question!
Is a "taxi" good or bad? Like a payday loan, the use of a taxi can have good or bad financial consequences. Let me explain.
Everyone has access to the public taxi service in their city or town - it's automatically assumed as a basic right. But taxis are expensive - aren't they? On a "per mile" basis, - perhaps $2 a mile or more, they cost a lot. We usually don't mind this, because used sensibly, taxis are only for short trips. We wouldn't dream of hiring a taxi to travel from LA to New York, for example, at $2 a mile.
There are people in our community for whom a taxi fare for even just a short trip represents a comparatively high percentage of their income. Their use of taxis often comes about because public or private alternative forms of transport are just not available at the time they are most required.
Is this right, or fair? We rationalise this on the basis that such usage of taxis is occasional, and just for short trips.
Payday loans are the financial equivalent of taxis.
Payday loans are expensive - just like the taxi fare - but they are only short term. A payday loan for $200 typically costs $20 per week or more. $20 for 2 weeks would cost $40 - yes that's expensive - but it's still a relatively small fee for the convenience of an unsecured loan.
(The justification of payday loan fees is a subject for another day. There are a number of factors, including risk and the level of administration costs).
Unfortunately in most jurisdictions the law requires disclosure of payday loan fees on an annual basis, it's called the Annual Percentage Rate ("APR"). So, a $200 payday loan kept for a year at $20 per week would "cost" $1,040 - which is indeed ridiculously expensive. That would be equivalent to an APR of over 500%, compared to a personal bank loan or credit card which would be 10% to 20% per annum.
Sounds expensive, but the APR measurement applied to a payday loan is a nonsense - it's like saying the "cost" of a taxi is $4,800 - in other words 2,400 miles from LA to New York at $2 per mile.
The fallacy is that nobody normally pays $4,800 for a taxi, and likewise nobody normally SHOULD pay $1,040 for a $200 loan.
But there's one big difference between a taxi and a payday loan, and it's this: The likelihood of exploitation of a borrower in the hands of an unscrupulous lender, is much greater than being taken from New York to LA against your will by taxi.
So it's very important that borrowers only borrow what they can afford to pay back within a short time frame. If a loan can't be paid back in time, payday loan fees can accumulate very quickly, and before long, the borrower is on the way to the financial equivalent of a taxi ride from LA to New York!
Summary:
Payday loans - like taxis - are a simple response to a genuine need, almost always in circumstances when an alternative is not available. Payday loans are not intrinsically bad, but their usage (like taxis) CAN have bad financial consequences.
So protect yourself and choose your "taxi" (ahem...payday lender) carefully.
Some important requirements when choosing your payday lender.
1. Only borrow what you can afford to repay in a short time (generally less than 4 weeks). EXPECT a RESPONSIBLE lender to spend a little time with you ensuring that you can afford the loan. (In many jurisdictions there is a legal obligation placed on the lender to do this).
2. See point 1. Irresponsible lenders will encourage you to get into debt, and are happy to keep you there by adding fees. NEVER ASSUME that just because your loan has been approved, it is appropriate for you.
3. Avoid loan extensions (sometimes called "rollovers") which can become VERY expensive over an extended time, and are the financial equivalent of your trans-continental taxi ride.
4. It's competitive out there - total up ALL the costs before you decide which lender to go with. Nominal fees can range between $5 to $25 per $100 borrowed per week. Some lenders charge application fees as well. Read the fine print, or get help from someone who is willing to read and interpret it for you.
5. Particularly check what happens if you want to pay off the loan early, and what the costs are (if any). Some lenders will charge a fee for early termination.
6. If you have any problems meeting the repayments, take action as EARLY as possible. Be PROACTIVE in contacting the lender to avoid default fees and other process charges. Most lenders will see your voluntary contact as a good sign, and will tend to be more co-operative and cost you less. In most jurisdictions credit law reinforces this approach.
