Have you seen the usual payday loan advertising? Usually they begin with “you need to buy a new car, new clothes, or you need a ‘quick buck’ to pay off debts??? Why not use a very cheap form of credit with very reasonable terms?” It sounds fantastic, right? These advertisements rage on the radio, television, in newspapers and magazines. But make no mistake: as with virtually every form of loan used to finance consumption, it is very easy for someone to get into financial trouble thinking that they are making a clever deal when taking a payday loan.
What is a Payday Loan?
A payday loan (also called a paycheck advance) is a small, short-term loan that is intended to cover a borrower’s expenses until his or her next payday (Wikipedia).
Payday Loan Risks
Loans can be very dangerous and a time bomb for the budget of those who find it challenging to manage their finances.
In most cases, payday loans are limited to a percentage of the borrower’s income. However, there are companies that provide loans without establishing any limit, leading many people to lose control over their finances. In desperation, and with a lack of financial education, many people resort to this mechanism to pay off monthly bills, forgetting that in reality they are only postponing the problem, as this continues to the following month and worse, it will still be necessary to pay back the loan.
Another risk related to payday loans are the interest rates. There are cases where someone who borrows $300 is charged over $100 for a seven day loan, and can then only meet the repayment by not paying other bills, such as rent or electricity. This can lead to a cycle of debt that makes things worse for the borrower. In other cases, the borrower has to pay up to 5 times more than the amount borrowed.
Take a payday loan or not?
Despite regulations – which include limits on loan fees and number of renewals – payday loans still create chronic and paralyzing debt and in general leave customers in a worse financial condition than prior to the original payday loan.
It is important to verify if the use of this mechanism is really necessary, or if there are better alternatives.
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