Payday lenders often use persuasive advertising to tempt you into thinking that they have the heaven-sent answer to your financial worries. But the reality is you should be aware of the potential dangers associated with payday loans. This type of loan can be difficult to repay and you could end up costing you a lot more than you borrowed if you are not careful. Before you apply for one, know what you are getting into and the risks involved in taking a payday loan. 

What is a payday loan? 

A payday loan, also called a short-term cash loan, is a form of credit with a short repayment period. Borrowers are usually required to make repayments when they receive their salary, hence the term “payday loan”. The repayment period is based on how frequently you get your paycheck, whether it’s weekly, biweekly or monthly. You can apply for a payday loan of up to $2,000.

Payday loans are convenient, but that convenience comes at a high price. On top of the principal amount, you will also pay fixed fees that are regulated by the Australian Securities and Investments Commission (ASIC). Under the law, there is a cap on the majority of payday loan fees. It usually consists of an establishment fee (maximum fee is 20 per cent of the amount borrowed) and a monthly loan fee (maximum of 4 per cent of the amount borrowed). Majority of payday lenders charge the maximum amount possible, but some lenders offer more affordable rates.  

Payday loans function differently than a personal cash loan. The main difference between a payday loan and a personal loan is the basic terms. The repayment period of payday loans can be as short as 16 days or as long as 12 months. Meanwhile, the minimum term for a personal loan is a year. 

Additionally, payday loans are easier to access than a personal loan. Depending on your location, you can apply for a payday loan online or through a physical branch with a payday lender. Payday lenders offer online applications and quick turnaround time to loan applications (typically within 24 hours). Meanwhile, personal loans can require a few business days to process. 

The popularity of payday loans is mainly attributed to the flexible lending criteria of its lenders. It is considered to be one of the most expensive financial products because payday lenders accept applications that more affordable lenders such as banks would reject. Customers with low credit ratings, poor credit histories and people with low incomes can apply for a payday loan as long as they can prove they will be able to repay their debt. 

To learn more about payday loans, click here. 

Risks of payday loans  

Payday loans are generally viewed as “quick-fix” solutions to financial problems. But this may not be the case. Below are the the reasons why a payday loan may do more damage than good for your financial situation:  

Very high costs 

While a payday loan may seem like an easy way out for your financial dilemmas, it has a lot of fees and it is not the cheapest option. As mentioned, payday loans have very high fees, which equate to high annual interest rates. Payday lenders are not legally obligated to disclose the annualised interest rate of loans.  

Payday lenders are legally required to give risk warnings on their website. However, these warnings are often obscure. For example, some payday lenders include in their website that you will be charged $7 per day for late payment, but this warning will be only explained in the small print. Overlooking such fees may result in higher repayments that you may not be able to afford. 

Make sure to read the fine print before applying for a payday loan. It is also advisable to make an informed decision when comparing and applying for a short-term payday loan. You can use a payday loan calculator to estimate how much you will pay in fees, the total cost of the loan and how much your repayments will be.

Has the potential to be a debt trap

One of the biggest dangers that can happen with payday loans is when you fall into a cycle of repeatedly extending your loan. 

If you are not able to make repayments on payday, you are allowed to extend the loan for another period. You will continue to spend borrowed money and accrue late fees that will keep piling up, which can only make your financial situation more problematic. 

If you default (or fail to pay off the loan on the set date), you will also be charged with default fees that will be added to your debt. The amount that can be charged in default fees can be double the amount you borrowed. 

In some instances, customers borrow money again to repay the last loan. And it can continue indefinitely, since there is no limit as to how many times a person can apply for this type of loan. Eventually, it becomes a vicious cycle that will pull you deeper into debt. 

It may affect your credit rating

Every loan application you make will show up on your credit report. While getting rejected for a loan will not directly impact your credit score, your actions following the rejection can. Particularly, if you continue to apply for loans that you are not eligible for, it will trigger several hard inquiries, which can hurt your credit score. 

If you can’t repay the loan due to the high costs, it may also negatively affect your credit score.

Conclusion

If it’s too good to be true, it probably is. Payday loans may seem like an easy way to deal with financial hardships in your life, but the high fees and short repayment period that comes with this financial product poses a real danger of putting you deeper in debt.

Most people that take on payday loans are going through financial hardships. Before you apply for a payday loan, you should explore other consumer loan options available to you. Additionally, read on what to consider when evaluating a payday loan. 

Do you want to know if a payday loan is the best option for your financial situation? Explore nestegg for more information.