Is There a Responsible Way to Use Payday Loans?

You may have heard about payday loans and wondered whether one might be right for you. Because payday loans are very high-interest loans that require you to give the lender a postdated check or other access to your bank account, you may want to consider very carefully if there is a responsible way to use payday loans.

Why Take Out a Payday Loan?

A payday loan, also called also called a "postdated check loan," "cash advance loan," "check advance loan," or "deferred-deposit check loan," is a short-term cash advance of up to $2,000 for a period of less than 91 days, or until your next paycheck. Because the interest rates and fees are extremely high, you will want to consider a payday loan only if you have tried other sources of cash:

A personal loan, which requires an application and a credit check. If you qualify you'll be paying a much lower interest rate. Friends and family, who presumably will charge you less than a payday loan creditor. An advance from your employer.

If you are facing a significant personal crisis, such as a health issue or auto repairs, a one-time payday loan may make sense if you remember that the loan is an advance against your next payday. This means that you will be short on your next payday-can you afford that?

Here is an example. You have a steady job and a checking account. Every two weeks, on Friday, you take home $1,800 from your job. Your paycheck is deposited directly into your bank account. On the Friday night a week after you have been paid your car beaks down and you need $500 to repair it. Your family can't help you and you have no credit cards, and your bank account is low.

You decide to get a payday loan. The payday loan company-conveniently located on a corner in your neighborhood-agrees to deposit $500 into your bank account.

Here are the conditions: Your next payday is the following Friday-seven days from now. The interest fee per $100 borrowed is $20. To borrow $500 for one week, you will pay a $100 finance charge plus the amount borrowed. Your total repayment will be $600. The annual interest rate (APR) for this loan is 1,040%.

Not only is the APR astronomical, but in order to get the loan you must give the creditor the right to debit your bank account. If on your next payday there are insufficient funds in your account you will owe the fee. The loan, plus the next week's fee, will roll over to the following payday. So if you miss the first payback date you will owe the $100 finance fee. Two weeks later you will owe the loan amount of $500 plus another $100 fee, for a total of $700.

You may think this sounds manageable and that you can repay the loan on your next payday. But remember that when your next payday comes in seven days, you won't have $1,800 in your bank account. You will have only $1,200 because you will have repaid the loan. If you are on a day-by-day budget, as many low-income families are, that may mean that by the middle of the following week you will run out of household cash. And consider this: if you cannot afford to spend $500 to fix your car today, are you sure that seven days from now you can spend $600 to repay your loan?

The Bottom Line

If you really, absolutely must take out a payday loan, be prepared to tighten your belt to make up for the additional expense you will have to absorb in the following weeks.