The United States economy is at the mercy of several conflicting factors at present, especially when you consider that unemployment continues to trend downwards while poverty has increased dramatically in numerous states nationwide. While the rising cost of living is undoubtedly an influencing factor, the situation is further exacerbated by an increasing level of consumer debt in the U.S., which reached the heights of $2.43 trillion in the summer of 2011. These unusual circumstances are leaving those who are employed struggling to make their income stretch, and forcing them to consider short-term solutions to ease their financial burden. (Related reading, see 7 Expenses That Are Keeping You In Debt.)
See: Credit and Debt Management
Payday loans are short-term financial arrangements designed to assist you in the case of an emergency or unexpected occurrence, and their primary purpose is to ensure that individuals remain cash rich even in the event of an unexpected expenditure. Despite numerous warnings from the federal government concerning these loans and predatory lenders, the Consumer Federation of America reports that payday agreements are now permitted in 41 states. Many of the lenders operate within restrictions, but nine states prohibit residents from undertaking them completely. So what exactly should individuals beware of when considering taking out a payday loan, and how can they use them responsibly to ease their everyday struggles?
Consider the Problem: What is Your Payday Loan for?
One of the most significant issues concerning the payday loan is the exceptionally high levels of interest that each can accrue. The average consumer can end up paying up to 400% interest on a two week loan of approximately $100. These extortionate rates can often trap unsuspecting borrowers in a needless cycle of repetitive debt, which is often exacerbated if the reason for their original loan was simply to cover a reduction in cash flow. Should this be the case, and a loan be taken out for general living expenses rather than a single and unexpected item of expenditure, then you can soon find yourself swimming against the rising tides of consumer debt.
So begin by assessing what your loan is for, and whether securing a short-term loan with substantial interest is the best way to achieve your goals. While they can be effective in making an unexpected purchase and providing short-term relief to a financial crisis, payday loans are entirely unsuited for helping you to settle monthly bills or living expenses. If you use them for this purpose, then you run the risk of either defaulting on your payment or taking out a further loan once you have repaid the original. (For more, check out The Best And Worst Ways To Raise Cash Quickly.)
Paying Attention to Detail: Can You Afford to Repay the Interest?
The issue of interest is critical, and although many states have implemented stringent caps on loan amounts and the total sums repayable, there is no single national guideline that regulates the payday loan. With this in mind, the rates of interest can fluctuate wildly between different states, starting at approximately 237% and moving upwards, depending on the individual lender and the duration of the agreement. It is therefore important that you understand this prior to taking out your loan, and calculate the total amount that would be repayable at the end of your agreement.
According to creditcards.com, the typical annual percentage rate (APR) on a credit card stands at 13%, and The Wall Street Journal reports that bank loans are often repaid at an average limit of 39%. The vast and variable levels of interest applied to payday loans can make it extremely difficult to calculate and to repay the total sum due. Always read and retain any fine print associated with your loan agreement, and make sure that you are fully aware of how much will be due and on what specific date. This should help you to discern whether it is an agreement you can adhere to, and also help you repay it as required.
Avoid Using Multiple Lenders at All Costs
There may be any number of reasons why you may use multiple payday lenders, but the truth remains that this can be an illegal and entirely inappropriate practice. To begin with, you should only secure a single loan against any given pay check, as it is an offense to have more than one advance on a salary payment. Not only is this against the law, but it can also leave you with a sum of debt that exceeds your monthly salary and renders you unable to make the agreed repayment in full.
Similarly, it is also unwise to secure a loan from a brand new company in order to pay an existing balance. Although this is not technically illegal, it is considered wholly inappropriate as consumers should only have a single payday loan at a time. Again, this also does little to help break your cycle of debt, especially as using one loan to eliminate another fails to deal with the financial issues that caused the need to source credit in the first instance. This is how multiple loans end up being borrowed against the same collateral, as short-term debt becomes a long-term problem. (To learn more, see 10 (Costly) Tickets To Fast Cash.)
The Bottom Line
While payday loans can be extremely useful in the case of an emergency or unexpected event, it is the consumers duty to understand their nature and use them responsibly at all times. Paying attention to the terms of the loan and the interest rate affiliated to it is critical, as this helps you to decide whether it is suitable for your needs and make repayments when necessary. Without this, you run the risk of becoming trapped in an unbreakable and destructive cycle of debt as you progress through 2012.