Payday Loan

Payday loans are small, unsecured short-term cash loans that people borrow to get through the month until their next salary kicks in. It is thus, a small principal being lent out, often at a very high-interest rate (up to the order of 30-50%). 

Payday loan is a prompt and unsecured financing option that allows individuals to mitigate any monetary crisis. The loan quantum here depends on the next paycheque of an applicant and is usually a portion of his/her total income.

Should you really go for Pay Day Loans?

Payday loans are meant for the working class who has difficulty in making ends meet, and are often broke at the end of the month. These loans need to be repaid within 7 to 60 days, depending on the loan provider. This short tenure, urgent nature of loan and repayment risk makes the loan very costly. But people are willing to take it just because of the convenience it offers in the case of an emergency. Payday loans in India are used for life events such as loans for weddings, medical emergencies and payment of school fees.  

Instant cash loans like this are approved based on a borrower’s credit profile, and it helps them manage the cash crunch arising between two paycheques.

How does a Payday Loan work?

Let’s understand how payday loans work with an example. Let’s assume that you are in need of ₹ 40,000 which is for an emergency, but you are still thirty days away from payday, and your bank account is sadly on the verge of being empty.

You go to one of the several online payday lenders who offer you convenient payday loans. As you expect your salary within seven days, you apply for a loan for tenure of seven days and for a principal amount of ₹ 40,000 at 9 % interest per month.

So, ₹ 40,000 (Amount borrowed) + ₹ 3600 (Interest) = ₹ 43,600 to be repaid within 7 days.

Essentially, if you have to take a 30-day loan, you are paying 108 % interest. If you take a 60-day loan, you are paying 108% interest. And in case you are late, you are likely to pay penalties on a per day basis.

Advantages of Payday Loans

1. Quick and Easy: It is a fast loan, i.e. often approved and disbursed within minutes, thereby no hassle of lengthy waits.
2. Minimum Documentation and Formalities: In most cases, the main requirement is to have a bank account and share some minimum personal and financial details. It does not require any extensive documentation like other loans.

Disadvantages of Payday Loans

1. Very High-Interest Rates: While the interest rate per day may seem manageable, when annualized, they turn out to be 400% annual interest (APR) or even more. The APR can even go up to 9000%, for very short loans. Let’s put that in perspective— credit cards have an APR of 9-30%, generally! So, now you can imagine how costly payday loans can be.
2. Debt Trap: If you are unable to repay the loan in the next month itself, the spiralling over often incurs huge penalties and additional costs. This often makes it impossible to repay going ahead, making the probability of a debt trap very real.

• If you don’t have a fixed workplace or salary you will not get the payday loan no matter how much you beg and promise for it. If you don’t have a checking account you can’t write a check meaning you cannot secure the loan and the lender will not process your order.
• If you need cash advance but don’t qualify for a payday loan for any reason, ask friends and family to lend you the money. Anyway a payday loan only supports small amounts of money therefore, asking your close ones shouldn’t be too difficult.
• If you haven’t managed to get the cash you need, consider applying for an unsecured personal loan you might even find that time wasn’t so important after all.

How to avoid Payday Loans

1. Borrow from Family or Friends

If you’re in a financial bind, a family and friends loan may be a great way to dodge a high-interest payday loan. In fact, you may even be able to borrow money with no interest.

Regardless of the interest rate you decide on, put your loan agreement in writing. This contract should include the amount of money you’re borrowing, the interest being charged or the collateral being used, the payoff period, and the payment amounts and due dates.

Failure to repay a loan of this type won’t hurt your credit, but it can result in legal action and a severed friendship or strained family relationship.

2. Seek Help from a Credit Counselor

A nonprofit credit counseling agency may be the way to go if you feel like you’re swimming in debt. A certified credit counselor can help you pay off your debt faster, lower your interest rates, work with you on a household budget and improve your financial situation. Depending on which services you utilize, nonprofit credit counseling agencies may provide their services at little to no cost.

3. Develop a Budget 

Create a balance sheet with cash inflows and outflows. Knowing how much you have coming in and where you’re spending it is crucial to managing personal finances. Next, consider eliminating any expenses that aren’t crucial. For instance, cable is a good place to start eliminating expenses. Look for another provider or drop to a cheaper package. Keep in mind that it is a serious mistake to borrow at high interest rates to pay regular monthly expenses. If you can’t pay the rent without a loan, move to a cheaper place.

4. Peer-to-Peer Lending

Peer-to-peer lending (P2P) platforms would be treated as non-banking financial companies (NBFCs) and regulated by the Reserve Bank of India (RBI).Peer-to-peer lending is a form of crowd-funding used to raise loans for people who need to borrow, from people who want to invest. It enables individuals to borrow and lend money without any financial institution as an intermediary, and extends credit to borrowers who are unable to get it through traditional financial institutions.

Pitfalls of Payday Loans

1. Very High-Interest Rates

While the interest rate per day may seem manageable, when annualized, they turn out to be 400% annual interest (APR) or even more. The APR can even go up to 9000%, for very short loans. Let’s put that in perspective credit cards have an APR of 9-30%, generally! So, now you can imagine how costly payday loans can be.

2. Debt Trap 

If you are unable to repay the loan in the next month itself, the spiralling over often incurs huge penalties and additional costs. This often makes it impossible to repay going ahead, making the probability of a debt trap very real.

• If you don’t have a fixed workplace or salary you will not get the payday loan no matter how much you beg and promise for it. If you don’t have a checking account you can’t write a check meaning you cannot secure the loan and the lender will not process your order.
• If you need cash advance but don’t qualify for a payday loan for any reason, ask friends and family to lend you the money. Anyway a payday loan only supports small amounts of money therefore, asking your close ones shouldn’t be too difficult.
• If you haven’t managed to get the cash you need, consider applying for an unsecured personal loan you might even find that time wasn’t so important after all.

3. Hidden Fees

Before taking out a loan, it is smart to ask your lender about any potential fees you have to pay in addition to the principal and interest of your loan. Below are the most common hidden fees to watch out for:

• Loan Application Fee – Do you need to pay a fee to apply for the loan?
• Undisclosed Missed or Late Payment Fee – Would you need to pay a fee if you miss a payment or pay it late?
• Returned Check Fee – Would you be asked to pay a fee if your check is returned for some reason?
• Customer Service Fee – Do you need to pay money to talk to a customer service agent?
• Overdraft Fee – Do you need to pay a fee if a payment to the lender is declined due to an overdraft on your account?

4. Not Considering Cheaper Alternatives

Some borrowing options that may be cheaper than a payday loan:

• A Personal Loan – Apply for a personal loan from a bank NBFC to cover your expenses are better than a Pay day loan.
• Salary Advance – Requesting an advance from your employer and getting the money deducted from your next payroll is also an option to consider. 
• Borrowing from Friends and Family – Ask to borrow money from relatives and pay them back. This option can often be interest-free. 
• Peer-to-peer lending – Peer-to-peer lending is a form of crowd-funding used to raise loans for people who need to borrow, from people who want to invest. It enables individuals to borrow and lend money without any financial institution as an intermediary, and extends credit to borrowers who are unable to get it through traditional financial institutions.

5. Difficulty to Repay

If you’re having difficulty making ends fulfill, it could be difficult to appear aided by the cash you will need to repay your loan. It may roll the loan over if you can’t pay. You then need to pay more charges along with your financial obligation gets larger and tougher to cover straight right back. In reality, an average of, pay day loan borrowers simply take over fifty percent at 12 months to cover back once again their loans.