Just as you’ve made ends meet this month, catastrophe strikes. Pipes burst in your house — and while you always wanted a swimming pool, you definitely didn’t want it in your basement. Or for it to smell like that. Then someone in your family texts you: The car’s totaled.
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Life happens, sometimes all at once. And even the most robust emergency fund might not cover it all. As you’re pacing in the muddy basement water, you start searching for fast solutions — and up pops an ad for a payday loan.
In a few simple clicks, you could have enough money to cover the costs. The relief washes over you, momentarily distracting you from the fine print about interest rates and rollover fees.
Slow your roll. That short-term relief could come with long-term financial consequences.
For experts like Michelle Kruger, a practicing financial planner, teacher and author, payday loans can be a “dangerous financial trap disguised as a helpful opportunity.” We spoke with her as part of GOBankingRates’ Top 100 Money Experts series to understand why payday loans so often backfire and what safer alternatives exist.
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According to Kruger, the biggest pitfall of payday loans is built into their very structure. “Payday loans are short-term, high-interest loans,” she explained. “They typically have a repayment term of two weeks with a repayment date coinciding with the borrower’s next pay date.”
Just how high can those interest rates get?
The District of Columbia Department of Insurance, Securities, and Banking reports that payday loan interest rates can exceed a whopping 400% APR. The agency has advised consumers to avoid payday loans despite their increased visibility and availability online, primarily because many payday lending operations take advantage of people in crisis by using deceptive, or even illegal lending practices.
Even if you meet your immediate financial needs with the initial loan, your next paycheck might not stretch far enough to repay it. That’s when rollover fees and penalties kick in, quickly turning a modest loan into a crushing financial burden.
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Those fees add up fast.
Kruger notes that payday lenders typically charge 15% to 20% in finance fees for each two-week loan. “On an annualized basis, that can equal an APR of 300% to 500%,” she said. By comparison, credit card interest rates, which are already considered high, tend to fall between 20% and 30% APR.
