Payday Loans – Rip Off or Smart Financial Tool?

Running short of cash with bills to pay? Should you consider a Payday loan to get you through a tight spot? If you’ve been reading any of the other financial advice articles on this website, you know that we make it a point to encourage you to make smart financial decisions.

Taking out a short term loan from a Payday lender with an effective annual percentage rate that makes most hand-held calculators produce an “error” message doesn’t sound like a smart financial decision. But is it really that cut-n-dry?

It is easy for someone who has money and is paying the bills on time to judge you and tell you that pay day loans are evil and immoral works, preying on the weak and helpless, because they are so expensive to pay off. But is it really that easy to dismiss this idea as a viable financial option for you? Let’s look at the realities of people living on the edge of financial ruin and see if this isn’t something that could be a positive idea in some cases.

The Negatives Are Obvious

The negatives of payday loans are obvious: They are flat out expensive. You can typically borrow up to a max of $700 and it usually has to be repaid within 7-14 days. Let’s calculate the math here:

• Your fee for this would typically run about $100 in “service charges” and interest
• You borrow $700
• You pay it back in 14 days

So, $700 borrowed with $100 interest for 2 weeks gives you an annual interest rate of around 500%. Kripes! That’s a lot of interest! Some places will let you borrow a little more than this and some places will let you take a little longer to repay it, but don’t kid yourself – that is a lot to pay for a little bit of money.

So why would anyone do it? Shouldn’t there be a law against it? It seems ridiculous to pay that much – at least until you get into a situation where you need to. And what kind of situation is that?

A Smart Financial Tool?

Here are a couple scenarios where getting a payday loan could end up saving you thousands:

• Without this money, your credit card payment will be late. If you are late on your credit card payment, the interest charged on your remaining balance will jump up to the “Default Rate” clause on your card agreement – meaning they’ll jack up your interest rate to a ridiculous level and likely increase your minimum payment calculation as well. You had a nice 9.9% interest rate and were paying $300 a month on your $10,000 balance. One missed payment and suddenly your rate is 24% and the minimum payment is now $800 a month or higher. Paying that $100 Pay Day loan fee to prevent this just saved your butt.
• One 30 day late on any credit card will likely trigger the “Universal Default” clause on many or all of your other credit card accounts. Multiply what happened above by ALL of your credit cards.
• One 30 day late will lower your credit score – which will likely trigger higher auto insurance premiums and prevent you from obtaining future credit at favorable terms.
• Late on a mortgage payment or car payment? If paying a $100 fee can prevent that – it is money well spent.

Are Your Finances On Terminal Life Support?

The problem with using payday loans occurs when you make it a month after month habit. Using these services should be a temporary, once in a great while, bandage. If your finances are on terminal life support, a payday loan isn’t going to help you.

But if getting through the next couple of weeks buys you enough time so a solution can be found (maybe getting a 2nd job will solve your situation, but it’ll take a couple weeks to get your first paycheck, for example), then by all means, save your credit rating! There are a lot of people out there who wish they could spend a mere $100 for a higher credit score or having their credit card rates set back to where they used to be.

Payday Loans – Rip Off? Certainly! Smart Financial Tool? Sometimes… but only when used wisely by people who have an exit strategy in place.