The most obvious problem with payday loans is the cost. We just did an example of a borrower who pays $75 in interest for a $500 loan. If that was the cost of interest for a full year, the interest rate would be 15%. That would be a decent rate for someone who has either bad credit or no credit, and is taking an unsecured loan.
The payday lenders are keenly aware that the likelihood of being repaid declines with the size of the loan
But the $75 is the interest charged for just two weeks. If you annualize the interest charged for two weeks, it comes to nearly 300%. In fact, 300% is on the low end. Payday lenders often charge 400%, 500%, or even much more.
What makes it even more concerning is the fact that it is the interest rate being charged to the people who can least afford it. If a person doesn’t have $500 today, they probably won’t be any more likely to have $575 in two weeks. But that’s what they’ll have to come up with.
People who take payday loans often get locked into an ongoing cycle. One payday loan creates the need for a second, which creates the need for a third, and so on.
The problem is that the borrower usually needs to take another payday loan to pay off the first one. The whole reason for taking the first payday loan was that they didn’t have the money for an emergency need. Since regular earnings will be consumed by regular expenses, they won’t be any better off in two weeks.
The lender might provide continuous financing by rolling over the loan every two weeks. The borrower will have to pay the interest every two weeks, but the original loan balance will remain outstanding.
Because the borrower will have to pay $75 every two weeks, he’ll end up paying $1,950 in interest in order to gain the one-time benefit of the $500 loan. Continue reading The REALLY bad part about payday loans