Why Do People Use Payday Loans? Pros & Cons Discovered

Why Do People Use Payday Loans? Pros & Cons Discovered

Sometimes we all need cash advances for unexpected or emergency expenses. And nowadays there are a lot of different ways to get them. But the main advantage of our technological era is you can get them online, faxless, and 100% safe. Among such great loan products are payday loans with no faxing, title loans, or pawn shop loans. Also, there are personal loans, home equity loans, and credit cards for those who need a more considerable amount. All these financial tools are available at private lenders, banks, or credit unions that also provide online lending. 

It is impossible to deny that payday loans are really convenient. There are no bad or good reasons to ask for money. Sometimes you just need it and are looking for a way to solve your problem. You can apply online, get paid quickly, and not worry too much about your credit score because many direct lenders work with all types of credit ratings. However, payday loan borrowers may disagree on how beneficial these loans are. So why are payday loans popular and who uses them? Let’s figure it out. 

What are Payday Loans?

Payday loans are short-term unsecured loans you borrow until your next paycheck arrives. They are also known as check advance loans or bad credit payday loans. 

This type of loan is easy to get but also simple to repay. The borrower receives money in their bank account on the next business day or earlier. It is possible to apply for most payday loans online. However, payday loans often have some loan fees (or finance charges), like late fees. In other words, if you have delays in loan repayment, you should pay the late penalty (usually 1% – 5% of the loan amount). 

Payday loans usually have a term of 14 to 30 days. The loan payment is often automatically withdrawn from the borrower’s bank account after receiving biweekly paychecks. Or, borrowers can provide a postdated check.

Unlike traditional loans, payday loans don’t need a hard check of your credit report. As a result, borrowers can afford them even with a low credit score or poor credit history.

But before taking out a loan, consumers must choose trusted payday lenders. This way, they can be sure that creditors work under federal law and don’t perform illegal actions.

It makes payday loans suitable for unexpected expenses when you need a cash advance as soon as possible. Plus, sometimes it’s even easier to borrow from payday lenders than to borrow money from relatives. 

How Do Payday Loans Work?

Part of the payday loans’ popularity is due to how easy it is to get them. 

  • First, a borrower chooses a payday lender who can offer them a needed amount
  • Secondly, a borrower applies for a loan. To get approval from payday lenders, a borrower needs to confirm the source of income (provide a pay stub), indicate a checking account, and prove identity with the appropriate document, like an ID card. 
  • Thirdly, make a direct deposit to the borrower’s bank account if the loan request is approved.

Payday lenders – also called alternative lenders – don’t do a hard check of your credit report. It means that no matter whether the borrower has a bad or good credit score, there is always a chance to get a loan application. Traditional banks and credit unions request a borrower’s credit report from credit bureaus. Meanwhile, private lenders don’t. So payday loan borrowers have no impact on their credit history. 

Payday Loan Interest Rates

So, we got to the main problem of payday loans – high-interest rates. Since the borrower takes a small amount for a short period, the annual percentage rate is not felt so keenly. But it’s a thing that can drag the borrower into the debt trap. 

Average payday loan interest rates are up to 375%. That’s what private lenders make their money from. And that’s the reason many payday borrowers get into debt cycles. 

A high-interest rate is a reason for federal regulations intervening in the settlement of payday loans. Please read the federal Truth in Lending Act. It gives you the necessary knowledge about the cost of the loan and other equally essential nuances.

Which States Prohibit and Which Allow Payday Lending?

Due to the predatory nature of the payday loan industry, they are banned in 17 states. These are Georgia, New York, New Jersey, Arkansas, New Hampshire, Montana, Colorado, South Dakota, Arizona, North Carolina, Connecticut, Maryland, Massachusetts, Pennsylvania, Vermont, West Virginia, and the District of Columbia.

Maine, Oregon, and New Mexico set interest rate caps for payday lending and other restrictions. If you live in these states, please read the lending laws of these states to see if you can apply for a payday loan.  

Payday loans are allowed in Alabama, Alaska, California, Delaware, Florida, Hawaii, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Michigan, Minnesota, Mississippi, Missouri, Nebraska, Nevada, North Dakota, Ohio, Oklahoma, Rhode Island, South Carolina, Tennessee, Texas, Utah, Virginia, Washington, Wisconsin, and Wyoming. 

Payday Loan Facts

Here are some payday loan statistics according to Pew Charitable Trusts

  • Twelve million people in the US spend $8 billion on loan fees each year. 
  • On average, a person who has taken a payday loan is in debt for five months. In doing so, an average American spends about $520 on commission.
  • The average income of a payday loan borrower is $30,000 per year.
  • 58% of borrowers cannot cover their monthly expenses. 
  • Even though payday loans are meant to help with unforeseen circumstances, 7 in 10 borrowers take them to cover recurring expenses, such as utility bills.
  • On average, a payday loan requires a repayment of $430, which is 36% of the average borrower’s salary. At the same time, most of those who take a payday loan cannot afford to pay more than 5% of their paychecks. Therefore, many borrowers either extend their payday loan or take another one because one payday loan that cannot be repaid creates the need to take another to pay it off.
  • Credit card cash advances can be expensive. Credit cards can have APRs ranging from 28% to 36%. But that’s nothing compared to the payday loan, which has an APR of 375%. 

Who Uses a Payday Loan?

It’s no surprise that after reading this article, you may wonder, “Who uses a payday loan?” and “Why do people still use payday loans?”. But unfortunately, understanding how predatory lending could be doesn’t protect you from needing money. 

Moreover, studies show that such loans are often used for primary or living expenses. For example, if you need to fix the car but don’t have available credit or money in your savings account, payday borrowing looks like a way out, doesn’t it? Furthermore, this is an unsecured loan and does not require any collateral, which the borrower may not have. In addition, to get a payday loan, a borrower usually only needs to prove income by showing their pay stubs. 

Here are some facts about people who use payday loans:

  • Over the past five years, approximately 6% of US residents have taken out a payday loan. 
  • More than half of borrowers (52%) are over 25 and under 46.
  • Homeowners are 43% less likely to use payday loans than renters (57%).
  • People with higher education take loans 28% less often than people without a four-year college degree (82%).
  • Most often, such loans are taken by people who are divorced – 13% and people who live with a partner – 10%. Widowed people are the least likely to apply for a payday loan. 
  • Having children also plays a role. Thus, parents make up 10% of those who take a payday loan. People without children make up 8%.

Alternatives to Payday Loans 

If payday loans don’t look attractive, choose between different options if you need cash as soon as possible. 

Title loans, for example, can offer a larger amount for borrowing, but your car will be collateral. Its main advantage is that you can drive your car while repaying the car title loan. If you can’t pay it back on time, the lender might seize your car through court.

Pawn shop loans also need collateral, but the interest rates will be lower: it ranges between 5% and 25% a month. 

Personal loans are a good option, especially if you need more than $1,000 and have a high credit score. But there are some options for people with bad credit. They will be more expensive than loan offers for good credit history but still cheaper than payday loans. 

Credit cards can cover emergencies in case you need, for example, to make an urgent purchase. Cash withdrawals usually come up with a commission. In addition, put on the card more than the minimum payment so you can avoid debt traps.

Bottom Line 

Payday loans are neither good nor bad. It has its advantages, such as speed of funding, no credit rating restrictions, and ease of access. Unfortunately, it also has disadvantages like high-interest rates. However, if you are borrowing it reasonably, this loan can save your budget within one business day.

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