What Are Payday Loans And Why Are They Bad Idea?

You find yourself in a financial emergency that cannot wait. You may also have a poor credit score, which means that no lender will give you the time of day.  You’re a high risk to them, and they feel that you won’t repay the credit should they give it to you.

Then, you come across an institution that doesn’t mind your low credit scores and comes to your rescue.  Besides, they do not need you to deposit any cash to access the credit.

Your financial problems are now solved, right? Wrong!

Accepting credit from such financial institutions could possibly be the worst financial decision you could make. These institutions are payday loan lenders, and there could be some severe repercussions should you take them up on their offer. So, what exactly are payday loans, and how do they work? Why aren’t they a good idea? 

Read on to find out more. 

So, What Are Payday Loans?

Payday loans are short term credits of up to AU$5000. Some lenders require that you repay them in a week or two. The term ‘payday loan’ derives from the terms of the loan – you’re required to pay them as soon as you receive your monthly salary.

The lender requires that you to sign a post-dated cheque, which should cover the principal and the interest of the payday loan. Once you do this, the lender deposits the requested loan into your bank account. 

They will then get their share once your salary hits your account without having to follow you up for payment. Seems simple enough, but why should you avoid payday loans?

Here are five good reasons why payday loans may be the bane of your financial existence:

These Loans Often Have Punishing Interest Rates

Payday loans represent easy to access credits. They may save you and get you out of a tight financial situation, but they do also charge higher interest rates than other types of loans.

These interest rates can be as high as 400%! The current average Australian payday loan rate is 24% per month. This rate is higher than personal loans, credit cards or mortgages, which charge between 8% and 22% per annum.

Payday loans put you in a position of paying expensive interest rates on a small credit facility.

Payday Loans Can Lead You Into A Perennial Debt Cycle

In some cases, you may be required to pay your loan within two weeks, and sometimes this may not be possible. The high interests and costs make these loans incredibly expensive, and at times, you may find yourself taking a new payday loan to clear the old one.

Also, you may find yourself in a revolving credit situation, where you need to a new loan out each time you repay the one that was due. This approach to lending may land you into a perpetual debt cycle that may be impossible to escape.

Some Loans Have False Advertising

Most payday loans do not adhere to strict legal frameworks. Some lenders may find loopholes with your loan contract, and if you do not read the small print, you may find yourself a victim of hidden charges.

For instance, you may be offered a loan with 17% APR, but in reality, the rate may be much higher due to processing fees and other loan charges.

Payday Loans Can Affect Your Credit Score

If you take out a payday loan and pay on time, there’s nothing much to worry about apart from the high-interest rates. The problem arises when you fail to pay on time. 

Most of these lenders recover their money by selling the loans to a debt collection agency. This process exposes your non-payment to credit reporting agencies, which will mark this down in your credit file lowering your credit scores.

Payday Loans Have Hefty Renewal Fees

One redeeming factor about payday loans is that you can rollover your loan should you not be in a position to pay it when it’s due.

 This rollover fee does not reduce the amount you owe on the loan. You’ll still owe the principal, interest, and fees for the rollover.

While rolling over your loan may sound like a good idea, in actuality doing this can result in you incurring more costs on renewals than on the principal loan amount. This situation may escalate into a vicious cycle as the months go on.

Final Thoughts

Payday loans may seem like an excellent option to turn to when you’ve got to attend to financial emergencies. They’re readily available and do not require any credit checks.

While they may seem like a tempting option if you have low credit scores, in reality, they may be nothing more than a debt trap.

These loans are ridiculously expensive and could land you into a financial hole. They can also wreak havoc on your credit scores, should you fail to make even one repayment.

Our verdict is, if you can, to avoid them and instead budget through any short term stress, or take out a personal loan from a reputable lender if you really need. This way, you’ll be on the safe side, and not trapped into high interest rates.

Share this post

Share on facebook
Share on google
Share on twitter
Share on linkedin
Share on pinterest
Share on print
Share on email