What Is A Payday Loan or Cash Advance?
What Is a Payday Loan?
A payday loan, also known as a cash advance, is a short-term loan for a small amount ($100 to $1000) that you are expected to repay by your next payday. Laws for payday loans vary from state to state and payday loans are not available in all states.
Payday loans typically have very high interest rates since a payday loan is an unsecured loan that is not based on your credit history.
The average Annual Percentage Rate (APR) for credit cards in 2011 was 13%; the average APR for a payday loan or cash advance was 365%. That’s 12 times more interest on a payday loan than on a credit card! Of course, you must have decent credit to get a credit card.
Why is the payday loan annual percentage rate so high?
Since payday loans are designed for borrowers with bad credit or no credit (without a credit check), lenders charge a higher rate to make up for the risks of giving an unsecured loan (a loan that is not backed by collateral) to someone who may not repay the loan on time – or repay the loan at all.
Interest Rate Comparison: Payday Loans vs. Credit Cards
Let’s compare interest rates between two types of consumer debt – a credit card and a payday loan.
The Annual Percentage Rate refers to the rate charged for a whole year. Even though a payday loan is about a two-week loan, it's helpful to compare similar figures; that's why we use APR.
|Loan Amount / Principal||
|APR / Interest Rate||
If you borrow $100 at a 25% APR, the interest charged for one month will be $2.08. This is determined by taking the interest amount charged for an entire year ($100 x .25 = $25) and dividing it by the number of months in a year (12). The interest charged for two weeks would be 96 cents (Divide $25 by 52 to determine the weekly cost and multiply by 2 for the 2 week term).
If you are offered a $100 payday loan for two weeks and you are charged $15, the APR is 390%. While $15 might seem like a reasonable amount, this comparison shows how expensive a payday loan is.
Also, a credit card has a 1-month grace period (the time between statements) that allows you to repay the loan, interest-free.
States that do not permit payday loans:
- New Hampshire
- New Jersey
- New York
- North Carolina
- West Virginia
If you live in one of these states you may have to look to other loan options for bad credit borrowers. You may also be able to use an online service to obtain your bad credit loan.
Payday loans can provide you with cash to avoid:
- Overdraft fees ($35)
- Bounced checks ($25)
- Late fees ($20 to $25)
- Reconnect fees ($45 to $65)
While payday loans are expensive compared to other types of loans, they are less expensive than paying fees. Overdraft fees may charge you $35 for being just $1 short and can charge you for multiple overdrafts.
People usually turn to payday loans and cash advances for unexpected costs that they are unprepared to fund. Since payday loans are so expensive, it might be more beneficial to repair your credit and get a loan at a lower interest rate. Or focus on building up a savings account balance that you can rely on in case of an emergency.
If you cannot wait to improve your credit, savings are not available and you must resort to payday loans or cash advances, read all the terms and conditions for the loan before you sign up for a payday loan. Be aware of the costs that come along with payday loans.