Many people ask me, when is it good to take out a payday loan – or is it every good to do so. The fact is, payday loans are not a cheap form of financing, and they never will be. However, does that make them bad or evil, as some people and companies would claim? Let’s take a look at the payday loan industry from an unbiased viewpoint (I feel given my background I am qualified to do so), and help explain when/if taking out a payday loan is a good move financially.
First of all, let’s start with some background information and details on the industry. Currently, payday loans are available in 33 states, with 17 states and one district creating laws that prevent such loans from being offered to the public (see details here: States The Do Not Allow Payday Lending). If you live in one of these 17 states, then you probably don’t even need to pay attention to the rest of the details below.
In addition, understanding payday loan fees can be fairly difficult. There are two components (typically) to such loans – the application fee, and the interest due. Payday loans are typically two-week loans in terms of duration, yet the costs and fees are required by federal law to be published in terms of Annual Percent Rate, or APR. Because other short-term funding options (bounced check, late utility, and late credit card fees, for example) are set in dollar terms, it can be very difficult to compare payday loan rates/fees to other such fees. However, you should be able to ask your lender how much the loan will cost on a per $100 basis, which will enable you to make a more fair comparison when deciding what option is best for you. Average interest rates are around 450% APR, or $10-$17 per $100 borrowed.
Ok, so with that background in mind let’s look more in depth at when it would be a good idea to take out a payday loan.
When Payday Loans Can Be Considered A Good Option
Really, the answer to this question is fairly simple – when sh*&T (er…life) happens, and you don’t have an emergency cash fund, and you have an expense that you MUST pay or you will find yourself in a worse financial position. Examples of such situations include:
- Injuries that require immediate medical attention
- Sudden car problems
- Financial problems that would prevent you from paying a minimum payment on a credit card, a utility bill, or other bill that will have late fees that are greater than the payday loan fees (this last part is very important to understand).
- Bounced Checks or other over withdrawls of your checking/savings accounts
Again, the key here to remember is, that it only makes sense to take out a payday loan when:
**Fees that you would pay if you DON’T take out the loan are GREATER then the loan rates.**
Let’s look at some of these examples. Let’s say you have a credit card due tomorrow, and the minimum payment is $75. If you don’t pay it you will have two problems:
- $35 late fee
- Your interest rate will go up to 25% (this doesn’t always happen with a non-payment, but can)
Even ignoring the possible interest rate hike, you may be better off taking out a $100 payday loan and paying the $17 in fees in order to avoid a $35 late fee.
This example can be applied to any of the above situations – just break down the fees into simple dollar terms and you’ll be able to see easily which is your best option financially.
When Payday Loans Can Be Considered A Bad Option
Really, in any other situation you should refrain from taking out the payday loan. These really are loans for emergencies only and should not be used otherwise. Do not take out a payday loan if/when:
- Your need is long-term and not immediate. This type of financing is for short-term financial problems only. If you try to finance a long-term situation with payday loans you will end up spending so much money on interest that you will dig yourself into a financial pit that will be extremely hard to get out of.
- Your need is not a true emergency. Just because your car broke down does not mean it’s an emergency – take a bus, carpool, do whatever you can to still get to work and wait until your next paycheck to fix it.
- You are paying for a want. Vacations, trips to Vegas, dinners at nice restaurants, electronics, and other toys do not count as emergencies. They are wants and should not be purchased with payday loans (yes I’m repeating my above point in different words, but doing so for a reason – this is very important).
- If you can’t pay back the loan on-time. People fall into the debt trap only when they take out too much, for a non-justified reason, and don’t know before hand if they will be able to pay off the loan.
As you can see, the question ‘when is it good to take out a payday loan’ really should be re-stated as ‘in what situations is a payday loan a possible option’. Obviously, you should try to avoid these situations as much as possible…but again “life” happens. If you are in such a situation now, then do your best to pay back your loan and not have to take another out (we will be starting our series on how to help with this situation in a few weeks).